World Development Report 2014 (Overview)

OVERVIEW
Risk and opportunity

Risk management can be a powerful
instrument for development
Managing risk for a life full of
opportunities: a mother protects
her child against malaria with a
bed net in Ghana.
FPO
Arne Hoel/World Bank
conducting it effectively, and how can
these obstacles be overcome? The WDR
2014s value added resides in its em-
phasis on managing risks in a pro-
active, systematic, and integrated
way. These characteristics under-
score the importance of forward-
looking planning and preparation
in a context of uncertainty. They
also highlight the necessity to address
all relevant risks jointly, using all avail-
able tools and institutions. From a policy
makers perspective, a proactive, systematic, and in-
tegrated approach to managing risks involves strik-
ing a proper balance between the contribution from
the state and the contribution from individuals, civil
society, and the private sector, with the goal of en-
suring that these contri butions are coordinated and
complementary.
The WDR 2014 argues that risk management can
be a powerful instrument for developmentnot
only by building peoples resilience and thus reducing
the effects of adverse events but also by allowing them
to take advantage of opportunities for improvement.
The WDR 2014 is not devoted to a detailed analysis
of specic risks. Its framework, however, can be im-
plemented to address particular, relevant sets of risks
in given regions and countries. Focusing on the pro-
cess of risk management allows the WDR 2014 to
consider the synergies, trade-offs, and priorities in-
volved in addressing different risks in different con-
texts, with the single motivation of boosting develop-
ment (box 1).
Risk and opportunity
Risk management can be a powerful instrument
for development
OVERVIEW

3
The past 25 years have witnessed un-
precedented changes around the
worldmany of them for the bet-
ter. Across the continents, many
countries have embarked on a
path of international integra-
tion, economic reform, techno-
logical modernization, and dem-
ocratic participation. Although
challenges and inequalities remain,
economies that had been stagnant for
decades are growing, people whose families
had suffered deprivation for generations are escaping
poverty, and hundreds of millions are enjoying the
benets of improved living standards and scientic
and cultural sharing across nations. As the world
changes, a host of opportunities arise constantly. With
them, however, appear old and new risks, from the
possibility of job loss and disease to the potential for
social unrest and environmental damage. If ignored,
these risks can turn into crises that reverse hard-won
gains and endanger the social and economic reforms
that produced these gains. The solution is not to re-
ject change in order to avoid risk but to prepare for
the opportunities and risks that change entails. Man-
aging risks responsibly and effectively has the poten-
tial to bring about security and a means of progress
for people in developing countries and beyond.
The World Development Report (WDR) 2014
focuses on the process of risk management, address-
ing these questions: why is risk management impor-
tant for development, how should it be conducted,
what obstacles prevent people and societies from
4 WORLD DEVELOPMENT REPORT 2014
Risk is a burden but also an opportunity
Why worry about risk? In recent years, a multitude
of crises have disrupted the world economy and
have had substantial negative consequences on de-
velopment. Because of the 200809 global nancial
crisis, most economies around the world experi-
enced sharp declines in growth rates, with ensuing
loss of income and employment and setbacks in ef-
forts to reduce poverty. When food prices spiked in
2008, riots broke out in more than a dozen countries
in Africa and Asia, reecting peoples discontent and
insecurity and causing widespread political un-
rest. The 2004 Asian tsunami, the 2010 earthquake
in Haiti, and the 2011 multiple hazard disaster in
northeastern Japanto name but a fewhave left
a trail of fatalities and economic losses that exem-
plify the increased frequency and intensity of natu-
ral disasters. Concerns about the impact of climate
change worldwide are growing, and so are fears
about the spreading of deadly contagious diseases
across borders. Indeed, the major economic crises
and disasters that have occurred in recent years and
those that may occur in the future underscore how
vulnerable people, communities, and countries are
to systemic risks, especially in developing nations.
Idiosyncratic risks, which are specic to individu-
als or households, are no less important for peoples
welfare. Losing a job or not nding one because of
inadequate skills, falling victim to disease or crime,
or suffering a family breakup from nancial strain or
forced migration can be overwhelming, particularly
for vulnerable families and individuals. Households
in Ethiopia whose members experienced serious
illness, for example, were forced to cut their con-
sumption by almost 10 percent and continued to be
negatively affected three to ve years later.
1
Health
costs from high levels of crime and violence amount
to 0.35.0 percent of gross domestic product (GDP)
a year for countries in Latin America, without even
considering the impact of crime on lost output
stemming from reduced investment and labor par-
ticipation.
2
Loss of employment in countries as dif-
ferent as Argentina, Bulgaria, and Guyana not only
has lowered income and consumption but has also
reduced peoples ability to nd new work, worsened
social cohesion, and in some cases increased domes-
tic violence.
3
Whether adverse consequences come from sys-
temic or idiosyncratic risks, they may destroy lives,
assets, trust, and social stability. And it is often the
poor who are hit the hardest. Despite impressive
progress in reducing poverty in the past three de-
cades, a substantial proportion of people in devel-
oping countries remain poor and are vulnerable to
falling into deeper poverty when they are struck by
negative shocks (gure 1). The mortality rate from
illness and injury for adults under age 60 is two and
a half times higher for men and four times higher
for women in low-income countries than in high-
income countries, while the rate for children under
age ve is almost twenty times higher.
4
Mount-
ing evidence shows that adverse shocksabove all,
health and weather shocks and economic crises
play a major role in pushing households below the
poverty line and keeping them there.
5
Moreover,
realizing that a negative shock can push them into
destitution, bankruptcy, or crisis, poor people may
stick with technologies and livelihoods that appear
relatively safe but are also stagnant.
BOX 1 Five key insights on the process of risk management from the
World Development Report 2014
Source: WDR 2014 team.
1. Taking on risks is necessary to pursue opportunities
for development. The risk of inaction may well be the
worst option of all.
2. To confront risk successfully, it is essential to shift from
unplanned and ad hoc responses when crises occur to
proactive, systematic, and integrated risk management.
3. Identifying risks is not enough: the trade-ofs and
obstacles to risk management must also be identi-
fed, prioritized, and addressed through private and
public action.
4. For risks beyond the means of individuals to handle
alone, risk management requires shared action and
responsibility at diferent levels of society, from the
household to the international community.
5. Governments have a critical role in managing sys-
temic risks, providing an enabling environment for
shared action and responsibility, and channeling
direct support to vulnerable people.
Risk and opportunity 5
Yes, confronting risk, as the possibility of loss, is
a burdenbut it is also necessary to the pursuit of
opportunity. Risk and opportunity go hand in hand
in most decisions and actions taken by countries,
enterprises, and families as they seek to improve
their fate. Indeed, risk taking is intrinsic to the pro-
cess of development. Consider a few examples. Since
the 1990s, most developing countries have opened
their borders to seek international integration and
higher economic growth, but in the process they
have also increased their exposure to international
shocks. Firms around the world have made invest-
ments to upgrade their technologies and increase
protability, but the debt required to do so has
made them more vulnerable to changes in demand
and credit conditions. From Brazil to South Africa,
millions of families have migrated to cities to seek
better job opportunities and health and education
services, where they have also become more exposed
to higher crime and benet less from communal
support. The motivation behind these actions is
the quest for improvement, but risk arises because
favorable outcomes are seldom guaranteed.
instrument for development
Whether risks are systemic or idiosyncratic, imposed
or taken on voluntarily, development can occur only
by successfully confronting risk and pursuing op-
portunity. Many crises and development losses are
the result of mismanaged risks. No less important,
many opportunities are missed because preparation
for risk is insufcient and necessary risks are not
takenthe risk of inaction. It is therefore essential
to shift from unplanned and ad hoc responses when
crises occur to proactive, systematic, and integrated
risk management. As such, risk management can
build the capacity to reduce the losses and improve
the benets that people may experience while con-
ducting their lives and pursuing development op-
portunities (drawing 1 and prole 1).
Risk management can save lives. Consider the
case of Bangladesh, where improved preparation for
natural hazards has dramatically reduced loss of life
from cyclones. In the past four decades, three major
cyclones of similar magnitude have hit Bangladesh.
FI GURE 1 Many people around the world are poor or live very close to poverty; they are vulnerable to
falling deeper into poverty when they are hit by negative shocks
More than 20 percent of the population in developing countries live on less than $1.25 a day, more than 50 percent on less than
$2.50, and nearly 75 percent on less than $4.00.
Source: WDR 2014 team based on data from World Bank PovcalNet (database).
Note: $1.25 per day is a widely used measure of extreme poverty. However, $2.50 per day is considered a more relevant measure of extreme poverty for some
regions, such as Latin America and the Caribbean. See Ferreira and others 2013.
a. All developing countries, 2010 b. Developing countries by region, 2010
500 16
14
12
10
8
6
4
2
0
$1.25 per day
$2.50 per day
$1.25 per day
$2.50 per day
400
300
200
100
0
0 2 4 6 8 10 12 14
US dollars
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Sub-Saharan Africa
South Asia
East Asia and Pacifc
Middle East and North Africa
Latin America and the Caribbean
Europe and Central Asia
collective action and ...through institutions
DRAWI NG 1 Risk management for everyone: A visual representation of key concepts
Drawing by Jason Victor for the WDR 2014.
Opportunity
Risk
To pursue opportunity, people must
confront risk
not one risk, but many
Disease
Natural
Disasters Crime
Financial
Crises
Job
Loss
Job
Loss
Disease
Crime
Natural
Disasters
Financial
Crises
...and often burdened with obstacles
to manage them
Job
Loss
Disease
Crime
Natural
Disasters
Financial
Crises
...and often burdened with obstacles
to manage them
Family
Banks
Community
Enterprises
Sharing risk with others can overcome
these obstacles
Government
Intl
Community
Knowledge
Protection
Insurance
Coping
tool for development
Job
loss
Job
loss
Financial
crises
Natural
disasters
Intl
community
Financial
crises
Natural
disasters
PROFI LE 1 The Gomez family: A modern tale of risk and resilience
Note: A video of this fctional story is available in nine languages on the World Development Report 2014 website http://www.worldbank
.org/wdr2014.
The Gomez family lives in a shantytown on the
outskirts of Lima. Only a few years ago, the fam-
ily lived in a rural village in the Peruvian Andes,
where they had a small farm. The region was
prone to droughts, and they could never earn
enough income to escape poverty. Many of
their neighbors had migrated to the city in the
1980s, pushed by civil confict in the countryside.
The Gomez family refused to go for fear of los-
ing their land and fnding nothing better in the
city. The risk was too large. Peru was a diferent
place then: infation and unemployment were
rampant, and the threat of social unrest was ever
present.
In the 1990s, the macroeconomy was stabi-
lized and the civil war ended. New opportunities
started to arise in urban and rural areas. At frst,
these opportunities eluded the Gomez family. A
dam had been constructed near their village, but
using its waters required the renovation of canals
on their farm. They applied for a loan from a com-
mercial bank but were denied, which came as no
surprise since it was their frst time applying. Mr.
and Mrs. Gomez came to believe that their chil-
dren had no future in the village and decided to
migrate to the city. This time, however, they did
not have to worry about losing their farm. They
had been given a property title and were able to
sell the farm to a neighbor, who had the capital
to renew the canals. The money from the farm
would give the Gomezes a cushion as they took
the momentous challenge of migration.
Lima, with just under 10 million inhabitants,
seemed like a huge and inhospitable place. That
is why they decided to move to the shantytown
where many members of their village had relo-
cated. There, they would fnd companionship,
cultural identity (all the festivals of their old
village were properly celebrated here), and, of
course, help fnding a job. Mr. Gomez found work
on a construction site, but it was irregular, with
frequent layofs. Mrs. Gomez had to pitch in, and
she was fortunate to fnd work as a seamstress in
a textile enterprise. The grandmother helped out,
taking care of the children when they returned
from school. Having two income earners (and a
willing grandmother) made the Gomez house-
hold more resilient to whatever might happen.
And things did happen. Mario, the eldest
son, was injured in a trafc accident. There was
no car insurance, and the family had to bear the
cost of Marios medical treatment. They could not
have done it alone, and they didnt have to. They
relied on a public hospital, run and fnanced by
the state. Medical treatment there was of uneven
quality, but it provided basic services. The fam-
ily had to spend some of their limited savings to
supplement the hospital services and buy medi-
cation, but all that was worth it because Mario
recovered.
The Gomezes had to dig into their assets once
again, but this time for a very diferent purpose.
Elenathe second daughter, whom everyone
regarded as the brains in the familycame
home one day and asked her parents if she could
study English in the evenings. This was a good
idea. Peru had recently signed several free trade
agreements (one of them with the United States),
and exporting companies had started to grow,
ofering jobs to young, qualifed people. English
would be a big plus.
Some months before, however, her parents
would have declined her initiative on the grounds
that it was not safe to be out at night. Police pro-
tection was scarce in the outskirts of the city, and
criminals took advantage of that. When a crime
wave eventually afected the Gomezes shanty-
town, the community put together neigh bor-
hood patrols (efective, although at times unduly
harsh). When Elena asked for English classes, the
safety risk had been reduced, and she could go
out to study in the evenings. As time passed, she
and her family would be well prepared to beneft
from the period of stability and sustained growth
that Peru was experiencing.
Confronting risks and seizing opportunities
may have put the Gomez family on the path out
of poverty, possibly forever. It was their work, ini-
tiative, and responsibility that made it possible,
but they could not have done it alone.
to undertake new promising ventures. Some farmers
in Ethiopia, for instance, choose not to use fertilizer
because they fear drought and other potential shocks
and thus prefer to retain savings as a cushion rather
than investing in intermediate inputs.
8
In contrast,
farmers in Ghana and India have been more willing
to take on risk in search of higher yieldsincreas-
ing their investments in fertilizer, seeds, pesticides,
and other inputsbecause they have rainfall insur-
ance.
9
When aggregated, these gains can have much
broader effects, contributing to improved productiv-
ity and growth for a country as a whole.
Crises and losses from mismanaged risks are
costly, but so are the measures required to better
prepare for risks. So, does preparation pay off? Ben-
et-cost analyses across a number of areas suggest
that risk preparation is often benecial in averting
costs, sometimes overwhelmingly so (gure 2). There
seems to be a lot of truth in the old adage that an
ounce of prevention is worth a pound of cure. For
example, a regimen of mineral supplements designed
to reduce malnutrition and its related health risks
may yield benets at least 15 times greater than the
cost of the program.
10
Similarly, improving weather
forecasting and public communication systems to
provide earlier warning of natural disasters in devel-
oping countries could yield estimated benets 4 to 36
times greater than the cost.
11
A cyclone in 1970 claimed over 300,000 lives, but
one in 1991 claimed almost 140,000, and one in 2007
claimed about 4,000. Casualties have been greatly
reduced by a nationwide program to build shel-
tersfrom only 12 shelters in 1970 to over 2,500 in
2007along with improved forecasting capacity and
a relatively simple but effective system for warning
the population.
6

Risk management can avert damages and prevent
development setbacks. Countries as different as the
Czech Republic, Kenya, and Peru offer recent com-
pelling examples where macroeconomic preparation
has shielded the economy from the negative effects
of a global nancial crisis. Having achieved lower s-
cal decits, disciplined monetary policy, and lower
current account decits, these countries experienced
a smaller decline in growth rates in the aftermath of
the 2008 international crisis than they did following
the 1997 East Asian crisis. The same benecial ef-
fect of macroeconomic preparation seems to have
occurred in many other low- and middle-income
countries.
7

Risk management can unleash opportunity. Risk
management toolssuch as improved information,
crop insurance, and employment diversication
can help people mitigate risk. The ability to mitigate
risk, in turn, can allow people, especially the poor, to
overcome their aversion to risk and be more willing
FI GURE 2 The benefits of risk management often outweigh the costs
Source: Wethli 2013 for the WDR 2014.
Note: The fgure shows the median of beneft-cost ratios across a range of studies in each category (with a minimum of at least four esti-
mates in each category). Above the dotted line, expected benefts exceed expected costs. The range of estimates within each category
can be substantial, refecting a diversity of intervention types and locations, and the sensitivity of estimates to variations in underlying
assumptions. However, in almost all cases, even the 25th percentile of the ranges are above the break-even point.
12
10
4
8
6
0
Vaccinations Improved
water and
sanitation
Early warning
systems
Nutritional
interventions
Earthquakes Floods
Measures to reduce damage from:
Break-
even
point
Tropical storms
2
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BOX 2 A risky world: Trends in risk across regions
The risks that people face have changed considerably over time,
although this evolution has sometimes varied across regions. Risks
have eased in some areassuch as maternal health, where the mor-
tality rate has declined in all regions. Conversely the incidence of
crime has increased substantially in Latin America and Sub-Saharan
Africa. Strikingly, the incidence of natural disasters has increased in
Source: WDR 2014 team based on data from World Bank World Development Indicators (database); EM-DAT OFDA/CRED International Disaster Database; United
Nations Ofce on Drugs and Crime Homicide Statistics (database).
Note: Figures show the simple average across countries in each region. OECD countries in the fgure are high-income countries that have been members of the
OECD for at least 40 years. All other countries are grouped into geographic regions. EAP = East Asia and Pacifc; ECA = Europe and Central Asia; LAC = Latin America
and the Caribbean; MENA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa.
a. Natural disasters include droughts, earthquakes, foods, and tropical storms.
b. Large recessions are identifed by following Barro and Ursa 2012 and using as a threshold a 5 percent decline in GDP per capita growth from peak to trough.
There were no large recessions in South Asia from 1991 to 2010.
every region of the world. While Latin America, the Middle East and
North Africa, and Sub-Saharan Africa all have sufered signifcantly
fewer years of recession in each decade since the 1980s, Organisa-
tion for Economic Co-operation and Development (OECD) countries
have experienced more.
0
0.1
0.2
0.3
0.4
OECD EAP ECA LAC MENA SAR SSA
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c. Incidence of natural disasters
a
1990
2000
2010
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a. Maternal mortality
19811990
19912000
20012010
19811990
19912000
20012010
19811990
19912000
20012010
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b. Homicides
Comparing the cost-effectiveness of preparing
for risk with that of coping with its consequences
is one of the important trade-offs that must be as-
sessed. The choice between these actions depends
in part on how the (certain) costs of preparing for
risk compare to the (often uncertain) benets of
doing so.
12
In addition, risk management requires
considering different risks and the relative need of
preparing for each of them (box 2). Given limited
resources, setting priorities and making choices
is both unavoidable and necessary. For instance, a
family living in a violence-ridden community faces
safety, health, and property risks and must choose
how to allocate its limited budget to protect and
insure against each of these risks. Likewise, a small
country prone to torrential rains and also exposed
to international nancial shocks must decide how
much to spend in ood prevention infrastructure
and how much to save to counteract the effects of
nancial volatility.
prices their products will command in the market.
And governments decide the level of policy interest
rates and scal decits in the presence of uncertain
external conditions, domestic productivity growth,
and changes in nancial markets.
The analysis of choice under uncertainty in
economics and public policy
It is only natural, therefore, that the analysis of choice
under uncertainty and scarce resources has been at
the heart of economics and public policy for cen-
turies. The basic approach to decision under un-
certaintyintroduced by Daniel Bernoulli in the
1700s and modeled formally by John von Neumann
and Oskar Morgenstern in 1944is based on the
notion that individuals optimize the expected util-
ity (or subjective perception of welfare) of possible
outcomes.
18
This expected utility approach relies on
individuals making rational choices, based on their
preferences for risk and their knowledge of potential
outcomes and respective probabilities.
Notwithstanding its valuable insights, this ap-
proach has been challenged on two important
grounds. The rst is that individuals do not seem to
operate in a fully rational manner, possibly because
uncertainty makes the decision process so com-
plicated that people prefer simple behavioral rules
that evolve over time but are not always optimal.
The work of Maurice Allais in the 1950s and Daniel
Kahneman and Amos Tversky in the 1970s focused
attention on the limitations and innate tendencies of
human behavior when confronting decisions under
uncertainty.
19

The second challenge to the basic expected utility
approach is that individuals do not make decisions
in isolation but in groups, mainly because the poten-
tial outcomes can be greatly affected by how people
act in coordination with others. The work of Duncan
Black in the 1940s and James Buchanan and Mancur
Olson in the 1960s emphasized the shortcomings of
and obstacles to collective action.
20
Although origi-
nally concerned with the states provision of public
goods, the public choice approach extends to actions
taken by any group, from households to communi-
ties of any size. The basic insight is how valuable and
at the same time elusive it is to coordinate collective
action, especially in the face of uncertainty.
A different strand of the economics literature is
also concerned with the collective action problem
and offers critical principles to overcome them.
In their pioneering work in the 1960s and 1970s,
Leonid Hurwicz, Roger Myerson, and Eric Maskin
When risks are taken on voluntarily in the pursuit
of opportunity, another trade-off emerges: expected
returns must be weighed against the potential losses
of a course of action. This trade-off is intensied
when a higher return is possible only if more risk is
accepted. That is often the case with nancial invest-
ments, where a lower yield is characteristic of a more
secure position, and higher yields with riskier posi-
tions.
13
A risk-return trade-off may also be perceived
for certain development actions: for instance, public
opinion and certain experts may link the pursuit of
higher economic growth with lower environmental
protection or higher inequality.
14
Although this and
other risk-return trade-offs may not be present, risk
management entails addressing them as a legitimate
possibility.
Risk management involves not only considering
trade-offs but also taking synergies into account.
These can make both preparation for and conse-
quences of risk less costly. They can also diminish
risks and increase expected benets. These win-
win situations are widespread and should be em-
phasizedwhich is not to say that they are costless
or always easy to implement. Investments in nutri-
tion and preventive health, for example, make people
more productive while reducing their vulnerability
to disease.
15
Similarly, improvements in the busi-
ness environment, such as streamlining regulations
and improving access to credit, can induce the en-
terprise sector to become more dynamic and grow
more quickly, while also making it more resilient to
negative shocks.
16
At the macroeconomic level, dis-
ciplined monetary and scal policiesreected in
moderate ination and sustainable public decits
accelerate economic growth while reducing high vol-
atility in the face of external and domestic shocks.
17
What does effective risk management
entail?
As the ancient Greek philosopher Heraclitus wrote,
the only thing constant is change. And with change
comes uncertainty. Faced with choices for bettering
their lives, people make virtually every decision in the
presence of uncertainty. Young people decide what to
study or train for without knowing exactly what jobs
and wages will be available when they enter the labor
market. Adults decide how much and how to save for
retirement in the face of uncertain future income and
investment returns, health conditions, and life spans.
Farmers decide what to cultivate and what inputs to
use not knowing with certainty whether there will be
enough rain for their crops and what demand and
may be positive (such as abundant rainfall or a wind-
fall in terms of trade) or negative (illness or war).
They may affect small groups (such as a family or a
rural community) or large ones (a region or a coun-
try). And they may occur suddenly (such as natu-
ral hazards or nancial shocks) or gradually (such
as demographic transitions, technological trends,
or environmental changes). Whether the outcomes
from those shocks are positive or negative, large or
small, individualized or widespread, depends on the
interaction between shocks and the internal and ex-
ternal conditions that characterize a social and eco-
nomic system (such as a household, a community,
or a country). Importantly, the effect of shocks on
peoples outcomes is also mediated by their actions
to prepare for and confront risk.
This interaction can be represented by a risk
chain (diagram 1), which can be applied to different
types of risks and contexts.
22
For example, whether
someone becomes ill during a pandemic depends
on how contagious the virus is (the initial shock);
population density and living conditions in given
areas (the external environment or exposure); peo-
ples individual susceptibility (internal conditions,
such as their age or the strength of their immune
system); and the steps they take to prevent becom-
ing sick or contaminating others, such as frequently
washing their hands or wearing a face mask (risk
management). Similarly, whether an enterprise can
successfully take advantage of new technology and
innovation depends on the characteristics of the
technology (the initial shock); the infrastructure in
the country, which may affect the enterprises access
to the technology (the external environment); how
innovative the enterprise is (internal conditions);
and how much capital the enterprise has accumu-
lated and how informed it is about the benets and
potential drawbacks of the new technology (risk
management).
In this context, risk is dened as the possibility of
loss. Risk is not all bad, however, because taking risks
is necessary to pursue opportunity. Opportunity is
dened as the possibility of gain, thus representing
the upside of risk. Peoples exposure to risk is deter-
mined by their external environment. For example,
whether a house is exposed to the risk of coastal
ooding depends on its location. Vulnerability occurs
when people are especially susceptible to losses from
negative shocks because of a combination of large
exposure, weak internal conditions, and decient
risk management. For example, a highly leveraged
nancial institution that has taken very risky posi-
tions without counterbalancing hedges is vulner able
studied the problem of mechanism design to
achieve efciency in markets, organizations, and
institutions. The critical insight here is that incen-
tive constraints should be considered as important
as resource constraints in understanding decision
making in the presence of uncertainty.
21
This in-
sight is vital when developing the best ways to coor-
dinate the collective action of any group, especially
under asymmetric information, diverging interests,
and limited knowledge. It forces analysts and policy
makers to see beyond aggregate resources and ques-
tion what informs and motivates the actions of peo-
ple and organizations, including actions related to
managing risk.
An analytical framework for risk management
The insights derived from the economics of decision
under uncertainty provide an analytical framework
for risk management. The World Development Report
2014 proposes that this framework consists of several
interrelated steps:
Assessing the fundamental goals of and motiva-
tions for risk management: that is, resilience in the
face of adverse events and prosperity through the
pursuit of opportunities (discussed in the rst two
sections above).
Understanding the environment in which risks
and opportunities take place (referred to below as
the risk chain).
Considering what risk management entails: that
is, preparing for and coping with both adverse and
positive events (presented below under The com-
ponents of risk management).
Assessing the main obstacles that individuals and
societies face in managing risk, including con-
straints on resources, information, and incentives
(discussed below in the section entitled Beyond
the ideal).
Introducing the potential role of groups and col-
lective action at different levels of society to over-
come the obstacles that people encounter in man-
aging risk (presented below in the section The
way forward).
Understanding the environment in which risks
and opportunities arise: The risk chain
The world is constantly changing and generating
shocks that affect individuals and societies. Shocks
to an economic or nancial shock. Likewise, a poor
household with few assets and volatile income may
be especially vulnerable to increased food prices.
Risk management is the process of confronting
risks, preparing for them, and coping with their ef-
fects. Resilience is characterized by the ability of peo-
ple, societies, and countries to recover from negative
shocks, while retaining or improving their ability to
function. Much of the emerging literature on risk in
a development context emphasizes the important
role that risk management can play in increasing
resilience to negative shocks. However, to increase
prosperity and well-being, risk management also
has an essential role in helping people and countries
successfully manage positive shocks. Indeed, success-
fully managing positive shocks is a critical part of
increasing peoples resilience to negative shocks over
time. For example, a farmers ability to withstand a
drought may be substantially inuenced by how the
yields from years of good rainfall were managed.
Thus the goal of risk management is to both decrease
the losses and increase the benets that people expe-
rience when they face and take on risk.
The components of risk management:
Preparation and coping
To achieve that goal, risk management needs to
combine the capacity to prepare for risk with the
ability to cope afterwardtaking into account how
the up-front cost of preparation compares with its
probable benet. Building on the seminal contribu-
tion from Isaac Ehrlich and Gary Becker, prepara-
tion should include a combination of three actions
that can be taken in advance: gaining knowledge,
acquiring protection, and obtaining insurance.
23

Once a risk (or an opportunity) materializes, people
take action to deal with what has occurred through
coping (diagram 2). A strong risk management strat-
egy would include all four of these components:
knowledge, protection, insurance, and coping. They
interact with each other, potentially improving each
others quality. For instance, better knowledge can
lead to more efcient decisions regarding the alloca-
tion of resources between insurance and protection.
Likewise, better insurance and protection can make
coping less difcult and costly. Several obstacles,
however, often make this risk management strat-
DI AGRAM 1 The risk chain: The nature and extent of outcomes depend on shocks,
exposure, internal conditions, and risk management
Note: The feedback arrows in the risk chain diagram represent the potential for the outcomes of past shocks to afect exposure and
internal conditions, as well as the propensity for future shocks. Similarly, the efectiveness of peoples risk management can signifcantly
afect the nature of and propensity for future shocks.
External
environment
Risk
management
Shocks
Internal
conditions
Outcomes
Risk
Outcomes
management
ks
Internal
conditions
Outcomes
anagement
Outcomes
While knowledge of risks often has been lacking
in developing countries, it is increasing in several
key areas, such as dealing with disease, economic
cycles, and natural hazards. And new technologies
are greatly helping to improve knowledge of poten-
tial shocks and inform responses to them. Farmers in
Ghana and 15 other African countries, for example,
receive specic market information through their
mobile phones, which helps them improve their
response to changes in agricultural prices and de-
mand.
24
Globalization and scientic advances have
also improved understanding of many pathogens,
including how they can be detected and diagnosed
rapidly to enable disease control. Improved tech-
nologies have also supported greater collaboration
among scientists and policy makers, as well as en-
abling the media to inform people, even in remote
parts of the world.
Protection
Protection includes any actions that lower the prob-
ability and size of negative outcomes or increase the
probability and size of positive outcomes. Develop-
ing countries have made substantial improvements
in some aspects of their risk protection in recent de-
cades. The percentage of people in low- and middle-
income countries with access to improved sanitation,
egy difcult to achieve in practice, as is discussed in
more detail below.
Knowledge
Obtaining knowledge and thus reducing the un-
certainties that people face when they confront risk
and pursue opportunities is the rst component of
risk management. Knowledge entails more than just
amassing information: while obtaining information
about possible events and their likelihoods is neces-
sary, knowledge also involves using that informa-
tion to assess exposure to those events and possible
outcomes and then deciding how to act. Knowledge
therefore contains elements of assessment and judg-
ment. Furthermore, peoples knowledge of risk de-
pends not only on the information they can access
but also on the quality of information that is pro-
vided by other social and economic systems. Indeed,
public policy has an important role to play in im-
proving the availability, transparency, and reliability
of information that may be relevant for risk prepara-
tion, including national account and labor statistics,
various market signals, and weather forecasts, among
others. Moreover, the state can contribute by reduc-
ing the uncertainty that can be created by erratic
policies, protracted implementation of reforms, and
frequent regulatory changes.
DI AGRAM 2 The interlinked components of risk management
Insurance
To transfer resources across people
and over time, from good to bad
states of nature
Knowledge
To understand shocks, internal and
external conditions, and potential
outcomes, thus reducing uncertainty
Coping
To recover from losses and
make the most of benefts
Protection
To reduce the probability and
size of losses and increase
those of benefts
Preparation Coping
formal insurance. For example, new devices for cars
can allow insurers to vary the insurance premiums
they charge based on the quality of peoples driving.
28

Together, knowledge, insurance, and protection
constitute preparation. The assets of households,
communities and governments, as well as services
provided by markets and the public sector, all inu-
ence preparation for risk, which in turn affects out-
comes. Overall, the extent of peoples preparation
for risk tends to be correlated with national income
across countries. However, interesting variations
within regions highlight the important role of policy
in determining preparation for risk, over and above
access to resources (box 3).
Coping
The nal component of risk management is coping,
which encompasses all actions that are taken once a
risk (or, alternatively, an opportunity) has materi-
alized. Coping, therefore, consists of deploying the
knowledge, protection, and insurance resources that
have been obtained during the preparation phase.
The relationship between coping and preparation
becomes very uid when confronting an evolving
risk. This includes updating relevant knowledge by
monitoring and assessing emerging risks and then
adapting and implementing any necessary and avail-
able responses.
The choice of how much to prepare for risk has
implications for the kind of coping that is needed,
which, in turn, can contribute to vicious or virtuous
circles in risk management. When effective prepara-
tion limits the damages from adverse shocks, coping
can be minimalleaving more resources available
for further investments in risk management, reduc-
ing vulnerability to future shocks, and so on. At the
household level, for instance, having health insurance
can facilitate medical treatment and recovery, while
reducing out-of-pocket expenses, when a family
member falls ill or suffers an accident. At the mac-
roeconomic level, evidence suggests that by reducing
losses from natural hazards, for example, preparation
for risk may sustain and even accelerate economic
growth.
29

In contrast, when preparation is limited or a
shock is unexpectedly large, coping can be haphazard
and require costly measuresleaving few resources
available for future risk management, worsening
vulnerability to shocks, and weakening households
ability to undertake new opportunities. For example,
the loss of assets that occurs from natural disasters
in countries as different as Ethiopia and Hondu-
rascaused by direct damage from a hurricane or
for instance, increased from 36 percent in 1990 to 56
percent in 2010; meanwhile, the immunization rate
for measles doubled from 41 percent to 83 percent
between 1985 and 2010.
25
Improved sanitation and
increased vaccinations, alongside other preventive
health measures, have helped reduce infant and ma-
ternal mortality rates. Similarly, following repeated
cycles of high ination during the 1970s and 1980s,
many developing countries established sound scal
and monetary policy frameworks, which have helped
reduce the intensity and incidence of large recessions
(see box 2). Increased use of early warning systems
has helped to protect populations exposed to natural
hazards, reducing fatalities when major events occur.
Insurance
To the extent that protection cannot completely
eliminate the possibility of negative outcomes, insur-
ance can help cushion the blow from adverse shocks.
Insurance includes any instruments that transfer
resources across people or over time, from good to
bad states of nature. In certain cases, insurance for
particular risks is provided by specialized markets
in the nancial system. However, because formal
insurance markets are often not widely available in
developing countries, a larger burden is placed on
self-insurance, which is often pursued through rela-
tively costly and inefcient means, such as holding
durable assets (like jewelry) that can be sold in the
event of a shock. Large numbers of households also
participate in informal, community-based risk shar-
ing, and micronance and microinsurance programs
are increasingly providing new instruments that help
people manage risk. Similarly, alongside traditional
safety nets, conditional cash transfers and other so-
cial insurance programs are a means for the state to
transfer resources to help the most vulnerable cope
with adverse circumstances.
26
There may be either synergies or trade-offs be-
tween insurance and protection as strategies to man-
age risk. To the extent that having insurance reduces
peoples incentives to prevent bad states from occur-
ring, insurance and protection act as substitutes for
each other. However, when the steps that people take
to attain protection facilitate or make it cheaper to
insure against adverse outcomes, protection and in-
surance can complement each other.
27
Being a non-
smoker, for instance, can make it easier and cheaper
to obtain health insurance. Protection often must
be observable for insurance and protection to be
complements. While observability is already highly
relevant for informal risk sharing in communities,
technology may also make it increasingly relevant for
world in the midst of the 200809 crisisincluding
bailouts of large nancial rms, scal stimulus, and
extended periods of monetary easinghelped calm
markets in the short-run, these responses may have
negative longer-term effects, including substantially
increased public debt and perverse incentives for -
nancial institutions risk taking.
drought, lack of insurance, and distressed sale of
assetshas substantial short-term as well as long-
term effects: poor households can effectively become
trapped in poverty, making them more vulnerable
to future negative shocks and less able to undertake
new ventures for improvement.
30
Similarly, while
the coping responses by governments around the
BOX 3 How does preparation for risk vary across countries?
Peoples preparation for risk at the country level includes actions by
and contributions from all social and economic groups and institu-
tions, including the state. An index of preparation for risk is charted
on the map above. The index, developed for the World Development
Report 2014, comprises measures of assets and services across four
important categorieshuman capital, physical and fnancial assets,
social support, and state supportthat infuence preparation for
risk. The component indicators for the index include: average years
of total schooling for the population aged 15 and over, and the
immunization rate for measles (human capital); the proportion of
households with less than $1,000 in net assets, and an index of access
to fnance (physical and fnancial assets); the percent of the work-
force who contribute to a pension scheme, and the proportion of
respondents stating that in general, people can be trusted (social
support); and the percent of the population with access to improved
Source: Foa 2013 for the WDR 2014. Map number: IBRD 40097.
a. Each indicator is rescaled to range between zero and one. The index, which is the average of the eight indicators, thus maintains the cardinal properties of the
indicators, rather than simply being an average of rankings across the components. This approach follows in part the methodology used in the construction of
the Worldwide Governance Indicators (see Kaufmann, Kraay, and Mastruzzi 2010). If necessary, each indicator is transformed so that an increase in its measure
represents an improvement.
sanitation facilities, and an indicator of fscal space based on gross
public debt as a percentage of revenues (state support).
a
This index shows that the extent of peoples preparation for risk
tends to be correlated with national income across countries, but
only to a certain extent. People tend to be the most prepared in
high-income countries (particularly in North America and western
Europe), and least prepared in low-income countries (especially in
Africa), on average. However, substantial variation exists within
regions. For example, Chile is reasonably well prepared for risk,
while its neighbor to the east, Argentina, has only average risk prep-
aration despite having a similar level of income per capita. Likewise,
Ethiopia has better risk preparation than other countries in the
region with similar or relatively higher income per capita. This
underscores the importance of policies, over and above income
level and access to resources, in determining preparation for risk.
Index of risk preparation across countries
Most prepared quintile Missing data Least prepared quintile
this information. Cognitive shortcomings are rel-
evant and pervasive obstacles to risk management in
many circumstances, even in advanced countries. In
the United States, for example, a survey revealed that
only 31 percent of homeowners in ood-prone areas
were aware of the risk.
31
The repercussions of extreme
instances of lack of information and knowledge
so-called deep uncertaintyare explored below.
Behavioral failures. Even if information exists, deci-
sion makers may be unable to turn knowledge into
actions and behaviors that prepare them for risk. In
many cases, decision and policy makers seem to have
short memories regarding the origins of crises of
various sorts. Systemic nancial crises, for instance,
are almost always preceded by unusually high credit
concentration and growth, and this process seems
to be well understood.
32
Yet policy makers often do
little to control credit booms. A false sense of security
may underlie peoples inability to manage prepara-
tion for risk in normal times (by saving for a rainy
day or completing disaster preparedness plans, for
instance). And a paradox of protection can arise:
risk protection that suppresses losses for a long pe-
riod creates a false sense of security, leading to de-
creased vigilance and risk awareness and potentially
resulting in larger future losses.
33
In many cases what
might be perceived as irrational behavior may in fact
be the result of distorted incentives, incorrect or in-
sufcient knowledge, or particular social norms and
cultural beliefs.
Obstacles beyond the control of individuals
hamper their risk management
Missing markets and public goods. Markets in areas
critical for effective risk managementcredit, insur-
ance, jobsare weak or even missing in many de-
veloping countries. So are public goods and services
essential for risk managementeconomic and polit-
ical stability, law and order, and basic infrastructure.
In fact, well-developed markets may be missing be-
cause supportive public goods are awed. If, for in-
stance, the justice system does not enforce contracts,
it makes little sense to buy health, vehicular, or house
insurance, and no such market will exist.
34
There are
many reasons why public goods are missing, but this
discussion considers only the most pertinent ones for
risk management. The rst, already discussed, is lack
of resources: the costly ood protections constructed
in the Netherlands, for example, are simply not fea-
sible for many similarly threatened developing coun-
tries, like Bangladesh or Vietnam. The second reason
Beyond the ideal: The obstacles to risk
management
If risk management can save lives, avert economic
damages, and unleash opportunityand, further-
more, if risk management is cost-effective and its
fundamentals are well understoodthen, why arent
people and societies better at managing risk? Al-
though the specic answer varies from case to case,
it is always related to the obstacles and constraints
facing individuals and societies, including lack of
resources and information, cognitive and behav-
ioral failures, missing markets and public goods, and
social and economic externalities. This realization
leads to an important message. Identifying risks is
not enough: the obstacles to risk management must
also be identied, prioritized, and addressed through
private and public action (box 4).
Consider the case of Mumbai. Its drainage system
is more than 100 years old and barely capable of han-
dling the annual monsoon rains. Reports and pro-
posals have repeatedly spelled out how investments,
such as installing pumping stations and clearing
out debris, are needed to expand the capacity of the
storm drainage system. Yet with few exceptions, the
proposals have not been acted upon. An exceptionally
large monsoon hit the city in 2005, leading to more
than 400 deaths, extensive damage to buildings and
infrastructure, and interruption of economic and -
nancial activity. Afterward, a fact-nding committee
made recommendations for overhauling the drainage
system that were distressingly similar to those made
in the 1990s. As of 2013, however, implementation is
again lagging. As a result, Indias nancial capital re-
mains highly vulnerable to monsoon rains.
Why arent people better at managing their
own risk?
Lack of resources. Even when a risk management
strategy is cost-effective, individuals and groups may
nd it difcult to undertake because of large up-
front costs and limited access to credit. Shortages of
assets and nance, which are especially acute in poor
and developing countries, can make the trade-offs
inherent in risk management harder to handle. Gov-
ernments may decide that, given their limited bud-
get, current consumption spending is more pressing
than investments for disaster risk reduction.
Lack of information and cognitive failures. Relevant
information may not exist or be available to decision
makers, or they may lack the ability to understand
BOX 4 Bringing the essentials of and obstacles to risk management together in policy design
This practical approach provides two important insights for the
design of risk management policies:
Be realistic. Simple risk management instruments should be pre-
ferred when capacity is low. Policy makers should concentrate on
low-hanging fruit and win-win solutions. Soft measures that change
incentives (such as improving zoning regulations for coastal areas)
are preferable as a starting point to engineered measures (such
as dikes to prevent fooding). Furthermore, it is particularly cost-
efective to strengthen the capabilities that are useful in managing
risks of diferent natures, such as the ability to complete large-scale
evacuations (which can be useful for either a hurricane or a nuclear
accident, for example). Realistic policy options should ensure that
risk management avoids unintended negative policy consequences;
provides the right incentives to build on everybodys best capaci-
ties; and protects the most vulnerable, who are often least able to
implement ideal but expensive solutions.
Build a strong foundation for improved risk management over time. It
often makes sense to create institutional arrangements when the
need for them is obvious, such as after a disaster event, and that
cannot be easily reversed once the memory of the event has disap-
peared. This institutional irreversibility should be combined with
fexible implementation and continuous learning. Policy makers
Designing efective public policy must go beyond simply identify-
ing potential risks to analyzing obstacles to risk management.
Diagram a below presents a set of screens to assist in decision mak-
should aim for robust policies that may not be optimal in the most
likely future, but that lead to acceptable outcomes in a large range
of scenarios and that are easy to revise as new information becomes
available. Starting with a strong foundation for risk management
requires a long-term perspective, creates the right incentives, and
minimizes the risk of unintended negative efects. It also helps
ensure that policies are fexible enough to be adjusted when new
information becomes available. (For more on both these insights,
see the discussion entitled Five principles of public action for bet-
ter risk management at the end of this overview.)
Thinking about both the fundamental components of and
obstacles to risk management with these lessons in mind can help
identify which specifc policies are most relevant in diferent con-
texts. For example, countries with limited resources or weak institu-
tional capacity should focus on policies that are foundational, while
countries that already have solid foundations for risk management
in place can aim for more advanced policies. This framework is used
throughout the World Development Report 2014 to organize and pri-
oritize risk management policies across the four main components
of risk management (knowledge, protection, insurance, and coping)
for diferent social and economic systems, from the household to
the international community. These are summarized in correspond-
ing tables for each of these systems (diagram b).
inghelping to identify critical gaps and revealing efective, low-
cost interventions.
a. A set of screens to aid risk management
b. A framework for public policy priorities
POLICIES TO SUPPORT RISK MANAGEMENT
FOUNDATIONAL ADVANCED
Knowledge
Protection
Insurance
Coping
How
much risk
are we
facing?
Are bad incentives leading to too
much or too little risk taking?
Are
decision-
makers ill
informed?
Are cognitive
and behavior
biases impairing
risk
management?
Are
resources
and access
to resources
too limited?
What policies
should be
implemented?
Because of
market failures?
Because of
government
failures?
Policy
design
Resource
assessment
Behavior
assessment
Information
assessment
Incentive assessment
Risk
assessment
rest of the world. Both negative and positive exter-
nalities may complicate the process of risk manage-
ment, making it less predictable and distorting its in-
centives. The solution is coordination and collective
action, which can be difcult to obtain when there
are wide differences in preferences, values, and expo-
sures. For instance, externalities and collective action
failures may be why reaching a binding international
agreement on greenhouse gas emissions is proving
so elusive.
Deep uncertainty and robust solutions
Deep uncertainty is an obstacle to risk manage-
ment that deserves special attention. Also known as
Knightian uncertainty in economic circles,
37
deep
uncertainty refers to a situation for which even ex-
perts cannot agree on appropriate models to under-
stand it, on the potential outcomes and probabilities
of its occurrence, and on how much importance
should be given to it. Taking a broad perspective, the
difference between deep uncertainty and ordinary
uncertainty is a matter of degree, uid, and evolv-
ing. Building knowledge helps to reduce the degree
of uncertainty. The history of science is full of cases
where deep uncertainty gradually became ordinary
uncertainty, amenable to management and control.
But while this happens, what should be done in the
presence of unknown unknowns?
Under conditions of deep uncertainty, it is pref-
erable to implement adaptive and robust policies
and actions that lead to acceptable outcomes in
a large range of scenarios and that can be revised
when new information is available and when the
context changes.
38
For monetary and nancial
policy, a promising practice is the use of stress test-
ing of banks and other nancial institutions using
a broad range of situations, including forward-
looking crisis scenarios.
39
Above all, plans that are
designed for the most likely outcomes but that in-
crease the vulnerability to less likely events should
be avoided. For instance, dike systems built only for
standard rainstorms and tides can actually increase
vulnerability by creating a false sense of security
and dramatically increasing the damages when a
ood does occur.
The way forward: A holistic approach to
managing risk
Can individuals on their own overcome the obstacles
to risk management they face? Although individuals
own efforts, initiative, and responsibility are essen-
is related to the political economy of risk manage-
ment. Governments may be reluctant to spend on
risk preparation because its costs are immediate and
observable while its benets, even if substantial, are
longer term and less visible.
Government failures. Risk management can also be
impaired by government failures stemming from
capture by interest groups, corruption of govern-
ment ofcials, and distortionary policies. On policy
capture, enterprises and people who are negatively
affected by certain risk management measures will
naturally tend to oppose them and be vocal about
it, while the people protected by these measures are
often not aware of them (and therefore do not sup-
port them), or lack the commensurate inuence of
active lobbies. Powerful tobacco and asbestos lob-
bies, for instance, can block useful health regulations
even in the presence of well-established scientic
evidence. On distortionary policies, sometimes even
well-intentioned measures can impair risk manage-
ment by distorting peoples incentives to manage
their own risk. An example is poorly designed post-
disaster support that creates moral hazard and dis-
courages risk management by individuals and rms.
Similarly, overly generous safety nets or nancial
sector bailouts can undermine incentives for risk
preparation.
Social and economic externalities. Risk management
actions undertaken by some people or countries
may impose losses on others. For instance, overuse
of antibiotics is creating ever more drug-resistant
bacteria. Similarly, excessive exploitation of common
natural resources such as oceans, forests, and the at-
mospherea phenomenon known in the literature
as the tragedy of the commonsis leading to en-
vironmental degradation, climate change, and a fu-
ture drop in economic growth.
35
In a different realm,
an expansion in the money supply to stimulate the
domestic economy in large advanced economies is
creating destabilizing capital inows to developing
countries, as well as eroding the wealth of domestic
savers and taxpayers. Similarly, instituting trade bar-
riers to protect domestic producers during economic
downturns imposes increased cost on trade partners
and can lead to trade retaliation, possibly turning a
downturn into a protracted world recession.
36
Other
risk management actions can generate benets for
people other than those bearing their cost, therefore
creating incentives to free ride. That is the case, for
instance, for countries that take costly measures to
reduce greenhouse emissions, which can benet the
The international community can offer expertise,
facilitate international policy coordination, and
pool resources when risks exceed national capac-
ity or cross national and generational boundaries.
These systems have mutual interactions, often
complementing and sometimes substituting for each
others risk management functions. For instance,
various mechanisms of protection and insurance
provided by communities, enterprises, the nancial
system, and the state can complement and improve
households self-protection and self-insurance. En-
terprises rely on macroeconomic stability, public
services, and nancial products to remain dynamic
and continue to provide income and employment
to people. The nancial system can provide tools of
insurance, saving, and credit only if enough house-
holds and enterprises are able to participate in the
system, and if the economy features a certain degree
of stability and predictability. Markets, in general,
can provide risk management tools and resources at
a growing scale if the necessary public services, such
tial for managing risk, their success will be limited
without a supportive external environment. While
individuals on their own may be capable of dealing
with many risks, they are inherently ill-equipped to
confront large shocks (such as the head of a house-
hold falling ill), systemic shocks (such as a natural
hazard or an international nancial crisis), or mul-
tiple shocks that occur either simultaneously or
sequentially (for example, a drought followed by a
food price shock and food insecurity).
People can successfully confront risks that are be-
yond their means by sharing their risk management
with others. They can pool their risk collectively
through various overlapping social and economic
groupings (systems). Indeed, the need to manage risk
and pursue opportunity collectively may often be a
key reason why these groups or systems form in the
rst place.
40
These systems extend in size and com-
plexityfrom the household to the international
community. They have the potential to support
peoples risk management in different yet comple-
mentary ways (diagram 3). Their different scope
may allow them to handle shocks and exposures that
match their scale (box 5).
The household is the primary instance of support,
pooling resources, protecting its membersespe-
cially the vulnerableand allowing them to invest
in their future.
Communities provide informal networks of insur-
ance and protection, helping people deal with id-
iosyncratic risks and pooling resources to confront
common risks.
Enterprises can help absorb shocks and exploit
the opportunity side of risk, contributing to more
stable employment, growing income, and greater
innovation and productivity.
The nancial system can facilitate useful risk man-
agement tools such as savings, insurance, and
credit, while managing its own risks responsibly.
The state has the scale and tools to manage sys-
temic risks at the national and regional levels, to
provide an enabling environment for the other
systems to function, and to provide direct support
to vulnerable people. These roles can be achieved
through the provision of social protection (social
insurance and assistance), public goods (national
defense, infrastructure, law and order), and public
policy (sound regulation, economic management).
DI AGRAM 3 Key social and economic systems can
contribute to risk management in complementary ways
The state
Social protection
Health, old age, and
unemployment
insurance
Assistance and relief
Public goods
Infrastructure
Law and order
National defense
Public policy
Macroeconomic
management
Regulatory framework
Civil society and the
private sector
Households
Family ties
Communities
Collective action
Enterprise sector
Jobs and income
Financial system
Insurance and credit
International community
Resources, expertise, global rules, and coordination
Peoples risk management
more prevalent and the relative roles of the house-
hold and the community are larger. For these coun-
tries, the international community may also play a
larger role through nancial assistance and capac-
ity building. As countries advanceand informal
mechanisms give way to formal onesthe relative
importance of the contributions from the enterprise
sector and the nancial system grow. The potential
role of the state is larger in less developed countries,
but in these cases the state tends to suffer from more
severe capacity and resource constraints. These limi-
as the rule of law and a sound regulatory framework,
are in place and effective. The international commu-
nity relies in part on responsible governments that
are willing to cooperate to address global risks; in
turn, the international community can help govern-
ments and countries that lack resources and capacity
for risk management.
The relative importance of these systems changes
with the level of development. In less advanced
countries, and especially in fragile and conict-af-
fected countries, informal mechanisms tend to be
BOX 5 Which systems for which risks?
Individuals face a multitude of risks, and various social and economic
systems can help them manage risks that are beyond their means
alone. But which systems are most appropriate for which risks? Two
important principles provide a way to prioritize risk management
across systems:
1. The principle of subsidiarity suggests that risks should be handled
at the lowest level capable of handling them, to take advantage
of the proximity to and greater knowledge of the agents most
directly afected by a risk, as well as the ability to monitor both
those agents and the risks that they face.
2. The principle of comparative advantage suggests that risks should
be managed by the system that can handle them most efectively.
Individuals and households are well placed to handle idiosyn-
cratic risks (such as minor injuries or income shortfalls) as long as the
potential losses remain relatively small. They have an advantage in
managing these types of risk because of their proximity to the level
at which the main impact occurs and because of their ability to
monitor conditions and eforts within the household.
As the size of potential losses increases, the tools that individuals
have at their disposal can quickly be exhausted. The enterprise and
fnancial systems can thus provide efective tools and mechanisms
(discussed in more detail in the sections below) for individuals to
manage potential losses from large idiosyncratic shocks (such as the
job loss of the head of the household or a burned-down house). The
state must sometimes provide substitutes for these functions when
markets are missing or not available to some.
Because systemic risks afect large groups of people, they can
hardly be managed by individuals alone. Communities have an
advantage in managing small systemic risks (such as local violence
or fooding) because of their proximity to the groups of people
afected and their potential advantage in monitoring and resolving
local tensions. The state also has an advantage in managing small
systemic risks (such as moderate fuctuations in aggregate prices
or regional food shortages) because of its capacity to control the
national macroeconomy and transfer resources between diferent
parts of a country.
Because many agents within a country are severely afected
when large systemic shocks occur, such as economy-wide banking
crises or natural disasters, the cross-support they can provide for
one another is limited. In other words, it is difcult for the private
sector alone to pool and insure for systemic risk. The state thus has a
unique role in managing large systemic risks because it has the scale
and tools to prepare at the national and regional levels. Support and
coordination from the international community is needed when
large systemic risks cross national borders or overwhelm national
capacities. Spotlights in the WDR 2014 feature case studies of risk
management by diferent support systems.
Types of risk that can be managed by diferent systems and examples featured
in the WDR 2014 spotlights
Small
idiosyncratic
risk
Large
idiosyncratic
risk Small systemic risk Large systemic risk
System best placed to
manage risk
Individuals and
households
The enterprise sector
and fnancial system
The community and
the state
The state and the
international community
Spotlight examples
Health risks (Turkey and the Kyrgyz
Republic)
Loss of employment and income (India)
Food shortages
(Ethiopia and El
Salvador)
Urban violence (Brazil
and South Africa)
Natural hazards (the
Philippines and Colombia)
Financial crises (the Czech
Republic, Peru, and Kenya )
Pandemics (global)
tional support to confront risk and pursue opportu-
nity. Extending Gary Beckers metaphor in A Treatise
on the Family, households are little factories where
goods and services of knowledge, protection, and
insurance are produced, using both intermediate
inputs obtained from the rest of society and the
pooled efforts and skills provided by family mem-
bers.
43
How can the household contribute?
Protection and risk pooling for its members. Protection
and insurance at the household level are particularly
important for idiosyncratic risks and even more rele-
vant when market or social insurance is lacking. Pro-
tection against adverse shocks is especially important
for the vulnerable within the household: the young,
the old, and the ill. For this purpose, families can
benet from the resources that are available in soci-
etyall the more so if these resources are increasing
and improving. Thus, for instance, higher incomes
and better access to health services have increased
immunization rates for measles to more than 70
percent in every region of the world, although Sub-
Saharan Africa still has much room for improvement
(gure 3a).
Moreover, sharing bad times (and good times)
occurs naturally in the household. Indeed, pooling
risk within and across family generations has been
a basic form of insurance from time immemorial.
The extended family plays an active role, especially
in developing countries. For instance, evidence from
Bangladesh, Ethiopia, India, Mali, and Mexico shows
that extended family members step in to help out in
a substantial way when their relatives fall ill.
44
Simi-
larly, evidence from several countries around the
world indicates that family members who migrate
assist their families through remittances when nega-
tive shocks occur in their place of origin.
45
Allowing its members, especially the young ones, to
make investments for the future. The role of house-
holds extends well beyond protecting and insuring
members against negative events. Households invest
in the human capital and social skills of their mem-
bers, especially the young, preparing future genera-
tions to manage the risks and opportunities they will
face. Schooling is one important example where
progress has occurred in recent decades. The aver-
age number of years of educational attainment has
increased since 1960 in all regionsmost substan-
tially in regions that initially had the lowest attain-
ment (gure 3b). However, the quality of education,
as measured by international exams in science, math,
and reading skills, is still lagging behind in many
tations call for a mutual, symbiotic relationship be-
tween the state, civil society, the private sector, and
the international community, as countries develop
(see below).
The state, civil society, and the private sector:
Helping one another manage risk
None of the social and economic systems presented
above works perfectly. Indeed, in certain cases they
hinder rather than help peoples risk management.
They have the potential, however, to become effective
support systems when their weaknesses are resolved.
The state thus has an important potential role to play
by complementing and supporting the functions
that households, communities, enterprises, and the
nancial system may serve. From this perspective,
the states role goes beyond the narrow purpose of
correcting market failures and extends to address-
ing systemic risks, building institutions that enhance
each component of risk management, and providing
direct support to vulnerable populations.
It would be nave, however, to ignore the fact that
the state often falls short in fullling its potential role.
Historically and throughout the world, examples of
government failures are regrettably abundant.
41
This
is all too vividly evident in the case of fragile and
conict-affected countries. What to do then? Civil
society, the private sector, and the international com-
munity can provide badly needed public goods and
servicesalbeit imperfectly. Especially, but not only,
in democratic societies, they can also help improve
governance and the delivery of public services by
generating mechanisms to make the state responsive
to the needs of the population and accountable for
its actions.
42

The discussion that follows assesses the poten-
tial contribution of each major system and suggests
ways to improve their performance, individually and
in combination with other systems. The states po-
tential contribution is presented in connection with
each system, reecting its overarching role and al-
lowing for an elaboration of specic recommenda-
tions for public policy, as well as a discussion of their
rationale and trade-offs.
The household
How can it foster resilience and prosperity?
For most people, the householddened as a group
of individuals related to one another by family ties
constitutes the main source of material and emo-
health insurance, signicantly reduces the incidence
of catastrophic medical expenditures, especially for
poor households.
47
Given the fundamental impor-
tance of health for everything else people do, there
is indeed great need for health insurance and much
room for improvement: only 17 percent of adults in
developing countries report having contributed to
health insurance, and this share is as low as 2 percent
in some low-income countries.
48
Fairness within the household. One would like to
think of households as nurturing, cohesive units.
All too often, however, abuse and discrimination
occur within the family, making it a source of, rather
than a solution to, risk. Compelling evidence shows
that womens economic and social empowerment
can strongly inuence whether the allocation of re-
sources within the household benets children and
promotes gender equality.
49
An evaluation of a cash
transfer program in South Africa, for instance, found
that pensions received by women improved the
health and nutritional status of girls but that trans-
fers received by men had no effect on either boys or
girls.
50
One important ingredient for womens eco-
nomic empowerment is access to the labor market,
which in several contexts is limited by inadequate
child care infrastructure and restrictive social norms.
low- and middle-income countries, without signs of
converging yet.
46

What characteristics improve the households
contribution to risk management?
Households are small but complex units. The moti-
vations of their members can range from altruism to
self-interest, the intrahousehold relationships can be
based on common goals or relative bargaining power,
and the households connections to society can be
uid or remote. These characteristics can have great
inuence on how well the household functions as a
rst line of support to confront risk and opportunity.
Access and participation. Communities, labor and -
nancial markets, and public institutions provide the
intermediate inputs that families build upon to
manage their risks. Continuous access to and par-
ticipation in those markets and institutions is critical
for families to be successful risk managers (so much
so in the view of the World Development Report 2014
that the following four sections are devoted to as-
sessing how they can contribute). To give just one
example: evidence from 59 countries suggests that
access to programs that limit out-of-pocket health
expenditures, such as social insurance and private
FI GURE 3 Education and health outcomes in developing countries are improving,
but unevenly
Source: WDR 2014 team based on data from World Bank World Development Indicators (database) (panel a) and Barro and Lee 2010
(panel b).
Note: Organisation for Economic Co-operation and Development (OECD) countries in the fgure are high-income countries that have
been members of the OECD for at least 40 years. All other countries are grouped into geographic regions.
a. Measles immunization rate b. Educational attainment of 1524 year-olds
100 10
9
8
7
6
5
4
3
2
90
80
70
60
50
1990 1960 1970 1980 1990 2000 2010 1995 2000 2005 2010
%

o
f

c
h
i
l
d
r
e
n

a
g
e
d

1
2
2
3

m
o
n
t
h
s
Y
e
a
r
s

o
f

e
d
u
c
a
t
i
o
n
Sub-Saharan Africa South Asia Middle East and North Africa
OECD East Asia and Pacifc Latin America and the Caribbean
tolerate violence or discrimination against women
and children. The campaigns should target both
men and women: more than 20 percent of women in
all regions, except Latin America and the Caribbean,
believe a husband is justied in hitting or beating his
wife for reasons like going out without telling him
and arguing with him.
56
The community
How can the community foster resilience and
prosperity?
Communities are groups of people who interact
frequently and share location or identity. Neighbor-
hood groups, religious groups, and kinship groups
are some examples. They work through informal
networks based on trust, reciprocity, and social
normswhat James Coleman and Robert Putnam
call social capital.
57
In this way, communities can
help their members by sharing idiosyncratic risks
and confronting common risks and opportunities.
Sharing idiosyncratic risks. Informal insurance is
particularly important for low-income households
and is sometimes their only real safety net. In the vil-
lage of Nyakatoke in Tanzania, for instance, with a
population of only 120 families, there are about 40
different insurance schemes (burial societies, rotat-
ing savings associations, and arrangements to share
labor and livestock).
58
These practices are also rele-
vant at the country level. Indonesian households, for
instance, have informal insurance against 38 percent
of the economic costs of serious health shocks and 71
percent of the costs of minor illness.
59
In Nigeria, in-
formal credit and assistance make up 32 percent of all
coping responses identied by households (gure 4).
Confronting common risks and opportunities. When
communities channel their social capital for collective
action, they can provide some publics goods (such as
basic transport and irrigation infrastructure) to pro-
tect against common adverse events (such as epidem-
ics, natural hazards, and crime and violence) and to
facilitate taking advantage of common opportunities
(such as new markets and technologies).
60
This col-
lective action can be especially important when state
capacity is low. The informal settlement of Orangi in
Karachi, Pakistan, for example, nanced and orga-
nized its own sanitation, vaccination, micronance,
family planning, and violence prevention, assisted by
a local nongovernmental organization.
Some countries and regions have much room for
improvement: female labor participation rates are
only 2030 percent in the Middle East, North Africa,
and South Asia, while in most of the rest of the world
they are well above 50 percent.
51

How can the state contribute?
The state has an important role to play in providing
social services and countering harmful social norms.
Policies that empower households as a unit and poli-
cies that empower individuals within households are
necessary.
Providing essential social services. Access to good,
even if basic, educational and medical services
can prepare people to confront major health risks,
handle life-cycle transitions, and take advantage
of work opportunities. In this sense, the drive for
equality of opportunities can also bring about re-
silience for households and individuals.
52
The efforts
of Thailand and Turkey to offer universal access to
quality health insurance deserve special mention.
Universal access to health care is likely to require a
partnership between the public and private sectors
to ensure both scal sustainability and sufcient
human resources.
53
For the most vulnerable, targeted
safety nets can have a dramatic impact in preventing
the coping responses that incur long-term costs
such as reducing basic consumption, withdrawing
children from school, selling productive assets in dis-
tress sales, or resorting to crime. Ethiopias Produc-
tive Safety Net Program is one successful example of
protecting the most vulnerable from food insecurity
while building community assets to better manage
climatic risks and raise productivity.
54
Increasing womens power in the household. This can
be done rst through economic empowerment: en-
couraging womens participation in the labor force
and, for poor households, directly increasing their
purchasing power. An example of the latter is con-
ditional cash transfer programs that make payments
to women directly; impact evaluations have shown
that these programs improve family and, especially,
childrens outcomes, including health and cogni-
tive development.
55
A second route is through social
and legal empowerment: enforcing legal measures
against abuse and domestic violence, eliminating
regulations that discriminate against women in asset
ownership or economic activity, and conducting
educational campaigns to counter social norms that
Reliance on personal interactions and informal
means of enforcement underlies the strength of
communities, but it is also the source of their weak-
ness. Communities struggle with systemic risk and
falter when risk management requires complex and
long-term preparation. Governments can help by
providing essential public goods and promoting in-
clusion and respect for diversity.
Providing essential public goods, such as infrastructure
and rule of law. Communities autonomous coping
and insurance mechanisms do not add up to ad-
equate risk management; they also need national and
local governments to complement their efforts. For
example, neighborhoods are potentially able to main-
tain their own drains, but urban ood prevention re-
quires citywide drainage and land use planning that
only city governments can provide. Similarly, neigh-
borhoods can patrol against petty criminals, but they
are powerless against organized crime.
Promoting inclusion and respect for diversity. Commu-
nities are not necessarily fair or reliable and can be
marked by strong inequalities in power and wealth.
62
They may exclude vulnerable people (chronically
ill, widowed), new entrants (migrants, refugees), or
those who happen to be different (ethnic minori-
ties). The state can help by enacting antidiscrimina-
What characteristics improve the
communitys contribution to risk
management?
Cohesiveness. Communities with strong ties between
their membersthat is, those communities endowed
with high bonding social capitalare better able to
organize collective action on behalf of the group.
61
In
fact, for local problems whose solution eludes mar-
kets and governments, a cohesive community can be
the missing piece of the puzzle. Cohesiveness is not
easy to achieve, however, when community members
have different values and cultural identities, as is in-
creasingly the case in urban communities. Moreover,
community cohesiveness is seriously compromised
when people are excluded or discriminated against.
Connectedness. Communities also need connections
to other communities and to markets; without these
connections they remain small and insular, lack po-
litical inuence, and are unable to accomplish any-
thing at scale. Communities with strong ties to one
anotherthat is, those communities that have high
bridging social capitalare more likely to collab-
orate with one another on mutually benecial risk
management projects and to coexist peacefully. Cities
with high religious or ethnically motivated violence,
for example, tend to lack routine interaction among
members of different groups and to be characterized
by divisive local leaders, media, and criminal gangs.
FI GURE 4 People respond to shocks on their own and by pooling risk with others
Source: WDR 2014 team based on data from household surveys, various years 200411.
Malawi
Uganda
Tajikistan
Uzbekistan
Afghanistan
Iraq
Maldives
Sudan
Nigeria
0 20 40
% of all coping responses when faced with a shock
60 80 100
Informal credit and assistance
Savings and sale of assets
Consumption reduction Formal credit and assistance
Employment or migration
costs.
64
Whereas most individuals on their own are
naturally risk averse and thus reluctant to take on
new ventures, in groups they become more willing
to pursue projects that involve more risk but also
promise higher returns. Firms, therefore, can serve
as natural vehicles to exploit the upside of risk, with
benecial consequences for individuals resilience
and prosperity.
65
Risk sharing. Enterprises allow risk sharing among
workers through collaboration; among owners of
rms through investment diversication; and be-
tween workers and owners through (formal or in-
formal) contractual arrangements. For risk sharing
within a given enterprise, achieving a certain size is
an advantage. The enterprise sectors of many de-
veloping countries, however, are dominated by self-
employment (gure 5). Rates of self-employment
are around 70 percent in South Asia and exceed 80
percent in Sub-Saharan Africa and are also pervasive
in developing countries in other regions. These high
rates of self-employment suggest that the incomes of
vast numbers of workers in developing countries are
vulnerable to diverse shocksa sick child, an equip-
ment failure, or a change in the weather could mean
the loss of a days income and more. They also sug-
gest that the enterprise sector is not beneting from
the specialization and increased productivity that
multiperson enterprises make possible.
Innovation and resource reallocation. When fueled
by competition, the enterprise sector can promote
innovation by adopting new technologies and real-
locating resources. In some instances, it may require
exit and entry of enterprises in the economy. This
process of creative destruction, as rst labeled by
Joseph Schumpeter,
66
can generate substantial ad-
justment costs but may be the only way an economy
remains resilient and prosperous in the face of con-
stantly changing conditions. Improving this dynamic
process can have signicant effects both on reducing
the risk of prolonged recessions and on increasing
aggregate productivity. For instance, one estimate
nds that making resource allocation as efcient in
China and India as it is in the United States would
increase total factor productivity by as much as 50
percent in China and 60 percent in India.
67
These
large gains, however, would also require developing
institutions and a business environment that can
support a high degree of dynamism in the enterprise
sectornot an easy task.
Worker, consumer, and environmental protection. Mo-
tivated by reputational considerations and properly
tion laws, conducting educational campaigns, and
encouraging interactions that promote cohesiveness
in the face of diversity.
Not only can governments support communities,
but community participation can increase the qual-
ity of the governance process and improve the per-
formance of government programs. People may not
heed the call to evacuate when government sounds
the disaster alarm, but they will run when warned
by a trusted fellow community member. Mobiliz-
ing communities voice, energy, and collective action
can help overcome some of the obstacles to improv-
ing risk management in countries and regions with
weak government capacity. For example, Afghani-
stans National Solidarity Program is constructing
rural infrastructure with community participation
and also laying a foundation for improved local
governance. In India and Uganda, disseminating
information on health and education entitlements
and outcomes through community-sponsored pub-
lic meetings has improved both government services
and community participation, leading to more vac-
cinations, more prenatal supplements, and fewer
excess school fees.
63

The enterprise sector
How can the enterprise sector foster resilience
and prosperity?
The enterprise sector comprises workers and owners,
the arrangements that organize their relationships,
and the technologies that turn production factors
into goods and services. Enterprises, the dening
unit of the enterprise sector, range from informal
to formal, from self-employment to partnerships
to giant multinational corporations, and from agri-
culture to manufacturing and services. Whereas the
owner of a single enterprise might seek to maximize
its prots, the enterprise sector as a whole encom-
passes the interests of workers, owners, and consum-
ers. Despite the possible important trade-offs among
these interests, the enterprise sector can help people
manage risk through several channels, as described
below.
For workers and owners, being part of a multi-
person enterprisethat is, a rmoffers the possi-
bility of sharing the benets and losses from special-
ization, collaboration, and innovation. Indeed, this
is one of the main motives behind the formation of
rms. As Frank Knight and Ronald Coase argued
in their seminal studies, rms have an institutional
advantage in providing cost-efcient ways of deal-
ing with uncertainty and overcoming transaction
enterprise sector that is exible is more capable of
responding to shocks by allocating resources within
and across enterprises, promoting risk sharing, and
innovating in an ever-changing world. In the recent
global nancial crisis, for instance, Denmark and
Spain were hit hard, yet their labor outcomes were
markedly different. In Denmark, job separations
were high but unemployment spells were short. In
contrast, in Spain the unemployment rate, which
stood at 25 percent at the beginning of 2013, has
shown few signs of abating since the start of the crisis.
The difference is arguably explained by the rigidity
within the enterprise sector in Spain, in contrast with
Denmarks propitious business environment. This
situation has prompted a serious debate and recent
reform proposals in Spain to remedy the situation.
More generally, the evidence indicates that countries
with less exibility in their enterprise sectors suffer
deeper and more prolonged recessions when nega-
tive shocks occur.
69
Formality. For enterprises, formality is dened as
compliance with laws and regulations. Whether
formality is benecial (for enterprises and the econ-
omy) or not depends on the quality of the norms
dictated by the state and the quality of the public
regulated by the state, the enterprise sector can con-
tribute to peoples risk management by providing
workplace safety, consumer protection, and environ-
mental safeguards. These protections are not guaran-
teed, however; and in some cases enterprises do un-
dermine them and generate losses for society. These
harmful practices can be corrected with stewardship
from the state, communities, and enterprises alike.
Given the right incentives, rms that make these so-
cial protections a priority can have substantial ben-
ets. A recent meta-analysis, for instance, found that
workplace wellness programs reduce medical and
absenteeism costsgains that accrue to both work-
ers and rms.
68

What characteristics improve the enterprise
sectors contribution to risk management?
Two characteristics enhance the ability of the enter-
prise sector to contribute to peoples resilience and
prosperity: exibility and, over time, formality.
Flexibility. Flexibility is the capacity of the entire
enterprise sector (owners, workers, technologies)
to adjust to changing conditions. It should not be
confused with the simple ease of ring workers. An
FI GURE 5 Self-employment is more prevalent in developing countries, especially in
Sub-Saharan Africa and South Asia
Self-employment, as percent of total employment, average 200406
100
Maximum
75th percentile
Median
Minimum
90
80
70
60
50
40
30
20
10
0
OECD East Asia
and Pacifc
Europe and
Central Asia
Latin America
and the
Caribbean
Middle East
and North
Africa
Sub-Saharan
Africa
South
Asia
P
e
r
c
e
n
t
25th percentile
Source: WDR 2014 team based on data from World Bank World Development Indicators (database).
Note: Organisation for Economic Co-operation and Development (OECD) countries in the fgure are high-income countries that have
been members of the OECD for at least 40 years. All other countries are grouped into geographic regions.
moving a country from the quintile with the greatest
labor rigidity to the one with the least rigidity im-
proves the speed of adjustment to shocks by one-half
and increases productivity growth by as much as 1.7
percentage points.
73
Furthermore, strong and inclu-
sive social insurance is necessary so that exibility in
the enterprise sector does not come at the expense of
the well-being of workers, their households, or their
communities (box 6).
Stronger and enforceable regulations for worker, con-
sumer, and environmental safety. While in many
areas regulations can be excessive and disruptive of
market forces, stronger and enforceable regulations
are needed to ensure workplace safety, consumer
protection, and environmental preservation. Market
failures derived from externalities and asymmetric
information are pervasive in these areas, requiring
direct intervention by the state. The deadly gar-
ment factory collapse in Bangladesh in 2013which
claimed the lives of more than 1,100 workersis a
sad reminder of the importance of the states moni-
toring and enforcement of regulations that cannot be
overseen by people on their own. These regulations
are important, particularly in states whose low in-
stitutional capacity requires them to prioritize their
interventions carefully.
The financial system
How can the nancial system foster resilience
and prosperity?
Through the provision of useful nancial tools and
responsible management of its own risks, the -
nancial system can shield people from the impact
of negative shocks and better position them to
pursue opportunities. Saving instruments (such as
bank deposits and liquid securities) enable people
to accumulate buffers for rainy days. Credit instru-
ments (such as education or mortgage loans) allevi-
ate nancing constraints, helping people to smooth
consumption following negative shocks but also to
exploit opportunities with greater exibility. Finally,
market insurance (such as health and residential in-
surance) provides a means to cover the costs of dam-
aging adverse events.
What characteristics improve the nancial
systems contribution to risk management?
Inclusion and depth. As Merton Miller and numer-
ous followers have argued persuasively, when nan-
services it offers. When these norms and services are
sound, the enterprise sector is characterized by less
self-employment and larger, more stable, and more
formal rms. These characteristics are all related. In-
formal mechanisms may be effective for small rms
and simple transactions, but they are insufcient
for larger rms and complex relations with workers
and markets. With adequate public regulations and
services, formal rms can benet from better legal
protection (such as contract enforcement) and better
use of public infrastructure (such as ports for inter-
national trade). That, in turn, can promote risk shar-
ing and innovation among enterprises. Moreover,
it can make enterprises more easily accountable for
their impact on worker safety and on consumer and
environmental well-being.
70

There are both synergies and trade-offs between
exibility and formality. In countries with effective
state institutions, formality enhances exibility. In
countries with weak state institutions and cumber-
some regulatory regimes, however, the cost of for-
mality can be too large for the majority of enterprises
and workers. In this case, informality is a means for
the economy to achieve a certain degree of exibility
and for workers to access a practical safety net.
71
Fig-
ure 6 provides a typology of countries based on the
exibility and formality of their product and labor
markets.
Public policy for the enterprise sector requires re-
forms that balance the economys need for ex-
ibility with societys need for legal and regulatory
protections.
A better business environment. Several of the ways in
which the state can contribute to productivity and
innovation can also enhance the resilience derived
from the enterprise sector. A better investment cli-
mate can improve risk management in the enter-
prise sector by encouraging adherence to sensible
rules and regulations and by increasing the sectors
capacity to adjust to new conditions. Most basi-
cally, secure property rights and regulatory certainty,
along with low costs for rm entry and exit, are es-
sential. In addition, although labor market reforms
in isolation are unlikely to be successful, reducing the
burden of labor taxes and streamlining regulations
is a critical component of a comprehensive set of
reformswhere the overall effect is larger than the
sum of their parts.
72
Alongside such complementary
reforms, recent cross-country evidence nds that
using nancial savings tools in high-income coun-
tries), and credit is used by about 8 percent (com-
pared with 14 percent in high-income countries)
although great heterogeneity exists across countries
(gure 7).
Stability. The Achilles heel of the nancial system
is its propensity for crisis. As observed in the semi-
nal work of Douglas Diamond and Phillip Dybvig,
the mismatch between the duration of banks assets
(long-term) and liabilities (short-term) makes the
nancial system inherently unstable.
75
If the nan-
cial system fails to manage the risk it retains, it can
hurt peopledirectly by hindering their access to
cial markets are competitive and function without
distortions, they can efciently provide more and
better tools and services to more people.
74
Indeed,
nancial markets can provide instruments and
services that help people face risks of varying fre-
quency, intensity, and nature, either idiosyncratic
or systemic. However, about 70 percent of people in
low- and middle-income countries do not use es-
sential nancial tools at all, compared with about
40 percent in high-income countries. Data on in-
dividuals nancial portfolios show that nancial
savings and insurance are each used by only about
17 percent of people in low- and middle-income
countries (compared with 45 percent of people
FI GURE 6 Countries vary widely in the flexibility and formality of their product and labor markets
Source: WDR 2014 team based on data from World Bank Pensions (database); World Bank World Development Indicators (database); World Economic Forum 2012;
and Schneider, Buehn, and Montenegro 2010.
Note: Economies in the top row are high (above the median value) in both product market fexibility and labor market fexibility; in the middle row they are high
in one or the other of the two; and in the bottom row they are low (below the median value) in both fexibility indicators. Similarly, economies in the frst column
on the left are low in both formal production and formal labor; in the middle column they are high in one of the two formality indicators; and in the last column
on the right they are high in both formality indicators. Only economies with data for all four indicators are considered, and median values are calculated within
this sample.
Armenia
Azerbaijan
Cambodia
Peru
Albania
China
Kazakhstan
Argentina
Croatia
Greece
Iran, Islamic Rep.
Romania
P
r
o
d
u
c
t

a
n
d

l
a
b
o
r

m
a
r
k
e
t

e
x
i
b
i
l
i
t
y
Production and labor formality
Less formal
Less
exible
More formal
More
exible
Algeria
Dominican
Republic
Ecuador
Egypt, Arab Rep.
India
Lesotho
Libya
Mexico
Russian
Federation
Trinidad and
Tobago
Yemen, Rep.
Bangladesh
Bolivia
Bosnia and
Herzegovina
Burundi
Chad
Colombia
Ghana
Haiti
Honduras
Jamaica
Mali
Nepal
Nicaragua
Pakistan
Philippines
Senegal
Sierra Leone
Venezuela, RB
Zimbabwe
Benin
Botswana
Burkina Faso
Cameroon
Cte d'Ivoire
El Salvador
The Gambia
Georgia
Guatemala
Guinea
Lebanon
Madagascar
Morocco
Sri Lanka
Tanzania
Thailand
Uganda
Zambia
Brazil
Bulgaria
Indonesia
Kenya
Kyrgyz
Republic
Macedonia,
FYR
Mongolia
Namibia
South Africa
Ukraine
Uruguay
Vietnam
Australia
Austria
Belgium
Canada
Chile
Costa Rica
Czech Republic
Denmark
Estonia
Finland
France
Germany
Hong Kong
SAR, China
Ireland
Israel
Japan
Korea, Rep.
Latvia
Lithuania
Malaysia
Mauritius
Netherlands
Norway
Poland
Singapore
Sweden
Switzerland
United Kingdom
United States
Hungary
Italy
Jordan
Portugal
Slovak
Republic
Slovenia
Spain
Turkey
nual credit growth of 25 percent, 40 percent, and 70
percent, respectively. Providing the right amount of
creditnot too much and not too littleis a major
concern for all countries.
Providing sound nancial infrastructure. Financial in-
frastructure consists of institutions that facilitate -
nancial intermediation, including payment systems,
credit information bureaus, and collateral registries.
Financial infrastructure also includes a regulatory
framework that fosters both consumer protection
and competition among nancial institutions. Mex-
ico and South Africa, for instance, have enacted ef-
cient consumer protection frameworks, which in-
clude ombudsmen to resolve disputes in consumer
nance.
78
Competition can lead to innovation in
nancial inclusion, as in the Philippines, which has
nance, or indirectly by hampering available credit
for enterprises and straining public nances, thereby
contributing to loss of jobs, income, and wealth. The
experience from 147 banking crises that struck 116
countries from 1970 to 2011 (map 1) is telling: the av-
erage cumulative loss of output during the rst three
years of crises was 33 percent of GDP in advanced
economies and 26 percent in emerging markets.
76
Both synergies and trade-offs may exist between
nancial inclusion, depth, and stability. By making
greater and more diversied domestic savings avail-
able to banks (and thereby reducing reliance on re-
versible foreign capital), greater nancial inclusion
and depth can enhance the stability of the nancial
system.
77
But excessive nancial inclusion and rapid
deepening can endanger stability. This applies es-
pecially to credit markets. For instance, the bank-
ing crises in Thailand (1997), Colombia (1982),
and Ukraine (2008) were preceded by excessive an-
BOX 6 Should access to social insurance be tied to work status?
The provision of basic insurance against the risks associated with ill-
ness and old ageespecially for the vulnerableis arguably a fun-
damental goal for public policy. But how is social insurance funded
and whom does it beneft? Traditionally, it has been funded through
mandatory payroll taxes levied on employers and employees, and it
has benefted contributing workers. The problem with this approach
is its limited coverage: in most developing countries, formal workers
(who contribute and beneft from social insurance) make up less than
half the labor force (and much less in Sub-Saharan Africa and South
Asia). The traditional approach thus ends up excluding many work-
ersmostly those who are low-income, self-employed, or work in
agriculture.
a
To close the coverage gap, several countries have set up noncon-
tributory systems for health and old-age pension insurance. Is it a
good idea to combine noncontributory and mandated contributory
systems? If the benefts from contributing to social insurance are
uncertain and the enforcement of mandated payments is weak, hav-
ing these parallel systems may undermine the incentives for employ-
ers to hire formally and for employees to seek formal employment. A
vicious circle could then ensue: informality breeds low coverage, and
the response to low coverage breeds further informality.
b

One possibility that merits discussion is delinking social insur-
ance from work status. This uncoupling would involve the following
public action:
a. Ribe, Robalino, and Walker 2012.
b. Evidence from Chile, Colombia, and Mexico shows that the interplay of contributory and noncontributory systems has led to declines in formal employment,
and there is widespread evidence that smaller, informal frms tend to be less productive and pay lower wages. See Levy and Schady 2013; Pags-Serra 2010;
ILO 2009; La Porta and Shleifer 2008.
c. Developing countries such as Mauritius and South Africa already rely primarily on noncontributory systems for pensions, while several other countries
including China, India, Thailand, Turkey, and Vietnamhave also begun to ofer universal access to health insurance. See Holzmann, Robalino, and Takayama
2009.
Allowing people to participate in health and old-age insurance
regardless of work status (employed or unemployed, and formal
or informal), requiring reasonably short vesting periods and por-
table benefts.
Making additional contributions to health and pension schemes
voluntary and clearly linked to predictable benefts that are
beyond the basic provisions granted by the state. Involving the
private sector in the management and provision of the voluntary
portion of social insurance contributions and benefts.
Providing basic health care and old-age pensions funded by the
state and directed to vulnerable populations but potentially open
to everyone (at least for health care).
c

Funding this basic provision through general government reve-
nues and user fees (for health care), to a level consistent with fscal
sustainability.
Clearly communicating with the public the characteristics and
limitations of basic provisions and the additional costs and bene-
fts of voluntary contributions.
Promoting fnancial literacy and fostering trust in the fnancial sys-
tem regarding its insurance function by macroprudential actions
and policy certainty.
Too ambitious or far-reaching? Maybe sobut worth discussing.
prudential supervision and intervene with timely and
robust policy tools, as the Republic of Korea did in
2011 in the wake of the international nancial crisis
by imposing a levy on bank noncore nancial liabili-
ties to manage speculative capital ows.
Ideally, macroprudential regulation would pre-
vent nancial crises. Some crises, however, are un-
avoidable, and a crisis resolution system is necessary.
How should losses be handled? In resolving crises,
countries should seek to pass bank losses to exist-
ing shareholders, managers, and in some cases un-
insured creditorsminimizing costs to taxpayers,
threats to scal stability, and future moral hazard. To
facilitate recovery from crises, governments and the
international community can contribute by reduc-
ing regulatory uncertainty through timely decisions
and effective global coordination.
Taking the trade-offs and synergies between inclusion,
depth, and stability explicitly into account. Evidence
suggests that in 90 percent of cases, national nancial
allowed mobile network operators to take on many
banking operations.
79
Moreover, to promote nan-
cial inclusion, the government can lead by example
through innovative practices. An interesting case is
Indias National Rural Employment Guarantee Act,
which has improved outreach to poor people living in
rural areas through the introduction of government-
to-person payments using a bank account.
80
Enacting macroprudential regulation for systemic risks.
To better manage the potential for systemic nan-
cial crises, countries should establish strong macro-
prudential regulatory frameworksframeworks that
consider the interconnectedness of nancial institu-
tions and markets and that address the nancial sys-
tem as a whole.
81
Making macroprudential regulators
independent, possibly by placing them under the cen-
tral bank, is the rst step in this directionas in the
Czech Republic, which in 2006 gave the central bank
explicit responsibility for fostering nancial stabil-
ity. Governments can then pursue pro active macro-
Source: WDR 2014 team based on data from World Bank Global Findex (database) and World Bank World Development Indicators
(database).
Note: The index of fnancial inclusion is calculated based on Global Findex data on the use of savings (percentage of adults who saved
money at a fnancial institution in the past year); credit (percentage of adults who borrowed from a fnancial institution in the past year);
and insurance (percentage of adults who personally paid for health insurance, and percentage of adults working in agriculture who
purchased agriculture insurance). GNI = gross national income.
FI GURE 7 Financial inclusion in savings, credit, and insurance across developing
countries at different income levels
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
5 6 7 8 9 10
I
n
d
e
x

o
f

n
a
n
c
i
a
l

i
n
c
l
u
s
i
o
n

i
n

2
0
1
1
,
b
e
t
w
e
e
n

0

a
n
d

1
CHN
IDN
KHM
LAO
MNG
MYS
PHL
THA
VNM
ALB
ARM
AZE
BGR
BIH
BLR
GEO
KAZ
KGZ
KSV
LTU
LVA
MDA
MKD
MNE
ROM
RUS
SRB
TJK
TKM
TUR
UKR
UZB
ARG
BOL
BRA
CHL
COL
CRI
DOM
ECU
GTM
HND
HTI
MEX
NIC
PAN
PER
PRY
SLV
URY
VEN
DZA
EGY
IRQ
LBN
MAR
TUN
YEM
AFG
BGD
IND
LKA
NPL
PAK
BDI
BEN
BFA
BWA
CAF
CMR
COG
COM
GAB
GHA
GIN
KEN
LBR
LSO
MDG
MLI
MOZ
MRT
MUS
MWI
NER
NGA
RWA
SDN
SEN
SLE
SWZ
TCD
TGO
TZA
UGA
ZAF
ZAR
ZMB
ZWE
GNI per capita in 2011, in natural logarithm
Sub-Saharan Africa
South Asia
East Asia and Pacic
Middle East and North Africa
Latin America and the Caribbean
in nancial markets. Sound macroeconomic man-
agement can provide an environment where house-
holds, communities, and enterprises are able to plan
for the long term and undertake their own risk man-
agement. Furthermore, macroeconomic policy can
address large systemic risks, which households and
other socioeconomic systems are unequipped to
handle on their own. As Robert Barro, among others,
has noted, macroeconomic crises with large welfare
costs have marked the world economy for decades
palpably so since 2007.
83
Policy makers have an es-
sential role to play in preventing these crises or at
least in mitigating their effects.
Macroeconomic stability. Business cycles are in-
trinsic to modern economies, and some degree of
volatility in aggregate prices, output, and employ-
ment is normal. Evidence indicates that the harm-
ful effects of volatility do not derive from moder-
ate uctuations but from high ination and abrupt
moves in economic activity. These effects percolate
throughout the economyreducing employment,
interrupting credit, and deferring investmentand
produce losses that lead to a decline in long-term
economic growth. Indeed, analysis across a set of
developed and developing countries over four de-
cades suggests that an increase in GDP volatility
sector strategies do not address specic trade-offs
between nancial development goals and the man-
agement of systemic risk, although more than two-
thirds of countries commit to achieving both goals
within their strategy.
82
A nancial policy committee
may provide a means for a country to better take
trade-offs and synergies in the nancial sector into
account and improve policy coordination. An in-
teresting example to consider is Malaysia, where the
central bank takes the lead in engaging major stake-
holders in nancial sector policy, including the min-
istry of nance and private sector experts. The goal
of this engagement is to prepare a national nancial
sector strategy for Malaysia that takes into account
trade-offs between promoting nancial inclusion
and development and managing systemic risk in the
nancial sector.
The macroeconomy
How can the macroeconomy foster resilience
and prosperity?
The macroeconomy is the platform where all eco-
nomic activity takes place: from consumption to
savings in households, from investment to produc-
tion in enterprises, and from borrowing to lending
MAP 1 Banking crises around the world, 19702011
Source: WDR 2014 team based on data from Laeven and Valencia 2012. Map number: IBRD 40098.
One crisis No banking crisis Two crises Three or four crises Missing data
prudential instrumentsaimed at curbing nancial
imbalances and volatile capital owsrather than
through monetary policy.
88
Flexible exchange rate regimes. Although debated for
a long time, exible exchange rates have proven to
be effective shock absorbers. That is true whether
the shock originated inside or outside the domestic
economy. Countries with exible exchange rates tend
to adjust betterrecovering more quickly and more
stronglyto deterioration in their terms of trade,
89

natural hazards such as earthquakes and storms,
90

and other shocks that may produce internal or exter-
nal imbalances.
91

Countercyclical and sustainable scal policy. World-
wide, scal policy has not made as much progress
as monetary policy in terms of effective process and
positive results. This is not surprising: scal policy is
inherently more complexhaving multiple objec-
tives and instruments and being immersed in the
political process. With respect to risk management,
scal policy in developing countries has suffered
from a procyclical bias that has tended to amplify up-
swings and worsen recessions.
92
In the past two de-
cades, however, several developing countries around
the world have put a premium on scal transparency
and discipline, building buffers during good times
with an eye toward future downturns. These insti-
tutional improvements explain the recent ability of
a large fraction of developing countries to conduct
countercyclical scal policy, mainly by turning in-
vestment and consumption spending in a direction
opposite to that of the cycle in general economic ac-
tivity (map 2 focuses on countercyclical consump-
tion spending). Independent scal councils can pro-
vide an important means to further institutionalize
such discipline (box 7).
Why is countercyclical scal policy useful? First,
it allows governments to continue to provide goods
and services and to maintain their public investment
programs in a stable fashion, even if public revenues
drop (as is normal in the downside of the business
cycle). Second, it provides resources to increase social
assistance and insurance to larger numbers of peo-
ple in need who are suffering from adverse cyclical
macroeconomic conditions. These two mechanisms
make a signicant contribution not only during the
recessionary part of the cycle but also for the long-
run welfare of people and the economy.
93
A third pos-
sible reason is to stimulate the economy. There is little
evidence, however, that discretionary scal stimulus
based on fueling consumption works. To the con-
from normal to crisis-related levels can decrease
long-run per capita GDP growth by around 2 per-
centage points a year.
84

Continuous provision of public goods and services. Part
of the reason why crises have an impact on long-run
growth is that they can result in an interruption or
deterioration in the provision of essential public
goods and services. These interruptions occur es-
pecially when governments are forced to undertake
drastic cuts in expenditures during downturns. This
was the case, for instance, in several Latin American
countries during the 1980s and 1990s, with more
than half the scal adjustment consisting of spend-
ing cuts in infrastructure investment.
85
Similarly,
social security spending dropped in nearly half the
countries in the Middle East and North Africa fol-
lowing crises in the region.
86
During the latest global
nancial crisis, education budgets fell sharply in the
majority of Eastern European countries: for instance,
by 25 percent in Serbia and 10 percent in Hungary.
87

What policies can best contribute to risk
management?
Experts have argued that macroeconomic policies
should be credible, predictable, transparent, and
sustainable. This is sensible advice. It can also be
presented more concretely in terms of risk manage-
ment: macroeconomic policy makers should behave
prudently during upswings to avoid costly coping
during downturns.
Transparent and credible monetary policy. Endowed
with independence and a drive for transparency and
credibility, monetary policy authorities have success-
fully brought down ination worldwide in the last
25 years: while 34 countries had annual ination
greater than 50 percent in 199094, only 1 country
(Zimbabwe) registered that rate by the end of the
2000s. Adopting a monetary policy framework that
creates incentives for long-term price stability, while
accounting for the business cycle, has been crucial to
defeating ination.
The 200809 international nancial crisis and
the ensuing recession in developed countries have
tested the improvements made in monetary policy
in developing countries. All in all, they have proven
to be resilient. One important issue to consider in
the wake of the crisis is whether nancial stability
should be included as a direct objective of monetary
policy. The jury is still out, but it can be argued that
nancial stability is best achieved through macro-
Dealing with contingent liabilities requires a combi-
nation of measures: rst, governments must provide
the right incentives for self-reliancefor example,
by replacing pay-as-you-go systems with fully capi-
talized old-age pension systems, and by letting risk-
takers in nancial markets suffer full losses from
failed ventures. Second, market solutions should be
encouraged by, for example, allowing the issuance of
catastrophe bonds in international markets to insure
against natural hazards. And, third, resources should
be provisioned for residual liabilities that the state
may have to bear.
The international community
When can the international community foster
resilience and prosperity?
Unmanaged risks do not respect boundaries, and no
one country or agent acting alone can deal effectively
trary, estimates of the Keynesian scal multiplier
the increase in GDP for every dollar of additional
government spendingrange only between 0.4 and
0.6 for most developing countries and between 0.6
and 1.2 for most developed countries.
94
Once the cost
of raising the necessary additional revenue (in terms
of taxes, debt, and red tape) is factored in, the net
multiplier is likely to be near zero or negative.
Finally, from a risk management perspective,
scal sustainability requires being aware of contin-
gent liabilities. Some of them are legitimate, such
as reconstruction and assistance in the aftermath
of natural disasters and the larger outlays required
to cover social insurance and medical treatment for
an aging population. Other contingent liabilities are
more controversial; nancial bailouts, for example,
can represent a large burden for the state: around
50 percent of GDP in Indonesia and Thailand after
the 1997 East Asia crisis, and over 40 percent of GDP
in Iceland and Ireland during the 200809 crisis.
95

MAP 2 Government consumption became countercyclical in more than one-third of developing
countries over the past decade
Source: WDR 2014 team estimations based on Frankel, Vgh, and Vuletin 2013 methodology. Map number: IBRD 40099.
Note: The map shows the evolution of the cyclical stance of fscal policy from 196099 to 200012. The cyclical stance is measured in a regression of the (Hodrick-
Prescott) cyclical component of general government consumption expenditure on its own lagged value, and the cyclical component of real GDP. The sign of the
coefcient on the cyclical component of real GDP indicates whether government consumption expenditure is procyclical (positive sign) or countercyclical (nega-
tive sign). The coefcient on the cyclical component of real GDP was estimated separately for the periods 196099 and 200012. Then, countries are classifed
as always countercyclical (in both periods); becoming countercyclical (only countercyclical in 200012); becoming procyclical (only procyclical in 200012); and
always procyclical (in both periods). The likely endogeneity of the cyclical component of real GDP was controlled for by using as instruments the (current and
lagged value of the) cyclical component of real GDP of the countrys main trading partners and international oil prices, as well as the lagged value of the countrys
own cyclical component of real GDP.
Always countercyclical Becoming countercyclical Becoming procyclical Always procyclical Missing data
countries face severe capacity constraints and have
weak or dysfunctional governments.
96
That is espe-
cially the case in fragile and conict-affected coun-
tries, where people face the most extreme risks and
obstacles to risk management, with limited access to
functioning markets, communities, and public insti-
tutions. People living in fragile and conict-affected
countries made up 15 percent of the world popula-
tion in 2010, but about one-third of people living in
extreme poverty.
97
Conicts can transcend national
borders, resulting in increased refugee populations,
spread of communicable diseases, and growing pres-
sure on public goods in neighboring countries ab-
sorbing affected populations. Sharing a border with a
fragile state can reduce a countrys economic growth
by 0.4 percent annually.
98
By improving economic
prospects and the environment for health, security,
and education, engagement by the international
community can reduce social and economic ten-
sions that iname and spread conict, while nurtur-
ing opportunities.
with a risk that crosses a national border. Once trig-
gered, pandemics and nancial or economic crises
can circle rapidly around an increasingly intercon-
nected world. Armed conicts can devastate people
and spill over into neighboring countries. Natural di-
sasters can ruin a country or an entire region. Climate
change is likely to intensify all these risks. Clearly,
risks that spread across and affect multiple countries
or generations call for international attention.
The international community is a fusion of rather
diverse agents, including sovereign governments, in-
ternational organizations, the global scientic com-
munity and media, and civil society. It can offer ex-
pertise and knowledge; provide protection through
global rules and regulations, capacity building, and
international coordination; and pool national re-
sources to better prepare for risk and alleviate crisis
situations.
Risks that exceed national capacity. The international
communitys engagement may be needed when
BOX 7 An independent fiscal council can help overcome procyclical fiscal bias
What is the problem? Fiscal authorities around the world routinely
deviate from sustainable plans and sufer from a procyclical bias:
they tend to run budget defcits and accumulate debt in good times,
and then lack adequate resources and fexibility (policy space) to
stabilize output in bad times.
A proposed solution. The creation of an independent fscal council can
provide the right incentives for the government to build up resources
to cope with cyclical downturns and long-run contingencies. The fs-
cal council would administer a set of fexible fscal rules mandated by
law: deciding on the allocation of defcits over time, signaling when
countercyclical action is justifed, and monitoring public debt sus-
tainability. Full delegation of policy making to an independent fscal
council is unrealistic because of the political and redistributive
nature of fscal policy. The government, following its political man-
date, would retain control over the distribution of expenditures and
the structure of taxation. However, isolating some aspects of fscal
policy implementation from the political process and delegating
them to an independent council can enhance fscal credibility and
accountability.
a

How can this solution be implemented? Fiscal councils should be
designed in a way that avoids political capture, the rise of govern-
ment incentives to ignore council advice, or the possibility of being
dismantled when conficts within government occur. An efective
fscal council requires independence from the political process
a. Debrun, Hauner, and Kumar 2009.
b. Calmfors and Wren-Lewis 2011.
c. IMF 2013.
d. World Bank 2013.
including competitive appointment and long tenure of council
board members, budget independence, and strong accountability
mechanisms (such as being evaluated by peer councils or interna-
tional organizations).
b

Has this solution been implemented anywhere? By 2012, 22 national
governments (and counting) had created fscal councils, with varying
characteristics and degrees of relevance.
c
The Netherlands Centraal
Planbureau and the Swedish Fiscal Policy Council are the closest to
full-fedged fscal councils. In Chile, two independent advisory bod-
ies provide key inputs for the projection of the structural revenue,
which in turn determines government expenditure through a fscal
rule. Acting as advisory bodies, fscal councils in Morocco, Kenya, and
Uganda provide ex ante and ex post assessment of fscal policies for
parliament.
If a council is not feasible, is there an alternative? Establishing an
independent fscal council requires the political appetite for auton-
omous institutions and strong governance underpinnings and
thus may not be possible in all countries. Where an independent
council is not feasible, a good foundation for fscal sustainability
would involve adopting transparent and comprehensive fscal
frameworks, including top-down approaches to budgeting. Since
the 2000s, Armenia, for instance, has formulated a three-year roll-
ing budgetary framework with expenditure ceilings and integrated
it into budgetary law.
d
nizations.
101
Increased air travel and trade in goods
and services, for instance, can provide free passage
to pathogens that cause infectious diseases, some
of which can travel around the world in less than
36 hours.
102
Similarly, nancial crises can spread
through an increasingly complex network of links
across nancial systems around the world. Rapid
economic growth that has relied heavily on carbon-
based energy is also related to slowly evolving risks
such as climate change and environmental degrada-
tion, with potentially irreversible consequences for
future generations.
What characteristics improve the
international communitys capacity to
manage risk?
The effectiveness of the international community
depends on how well it can ll in knowledge and ca-
pacity gaps, establish rules and standards that guide
nations in managing their risks, and facilitate and
coordinate collective action to manage risks that go
beyond national borders. In turn, collective action
is facilitated when agents within the international
community are united by shared preferences and
objectives, or when certain actors have the ability to
mobilize resources and enforce agreementseven in
the absence of cohesion or unity across nations.
International support is also needed when very
large shocks, such as natural disasters and nan-
cial crises, result in losses that dwarf a countrys
resources. That can happen even in large and more
developed countries, as the Euro Area crisis clearly
demonstratesalthough low-income countries are
disproportionately affected by economic risks and
disasters. For example, the Aceh province in Indo-
nesia bore the brunt of a powerful earthquake and
tsunami in 2004, leaving more than 500,000 people
homeless and an estimated economic loss of 97 per-
cent of Acehs GDP. The international community set
up a special multidonor fund to support reconstruc-
tion and establish early warning systems, efforts that
almost 10 years after the tragedy have largely proven
to be a success.
99
Success does not always follow,
however, as illustrated by the disappointing results of
the international communitys intervention in Haiti
after a powerful earthquake in 2010.
100

Risks that cross national borders. Openness and
modernization have made economic, social, and
ecological systems increasingly interconnected (g-
ure 8). Along with opportunities for growth and
poverty alleviation, this interconnectedness has
also created a set of risks that cross national bor-
ders and require critical risk management from the
international community, including regional orga-
FI GURE 8 Economic, financial, and social interconnectedness are on the rise
Source: WDR 2014 team based on data from World Bank World Development Indicators (database), Bank for International Settlements
Consolidated Banking Statistics (database), and World Tourism Organization Yearbook of Tourism Statistics (database).
Note: All series are indexed to 100, with 2000 as the base year.
200 500
450
400
350
300
250
200
150
100
50
0
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
180
160
140
120
100
80
60
40
20
0
I
n
d
e
x
I
n
d
e
x
Ratio of foreign claims of international banks on all countries to GDP
Ratio of total trade to GDP Tourist arrivals per capita Internet users per capita (right axis)
If incentives are aligned: Pursue proactive and well-
coordinated interventions. When incentives are aligned
and a course of action is clear, scaling up risk manage-
ment requires proactive and well-coordinated inter-
ventions by the international community. In dealing
with risks such as pandemics or nancial crises in
an interconnected world, the effectiveness of these
actions rests critically on supporting the capacity of
individual countries to monitor and contain risks
in their territory. For example, while 36 donors pro-
vided support to more than 100 developing countries
to prepare for a possible pandemic of avian u
(H5N1) from 2005 to 2010, local monitoring was
essential to contain the virus. More resources should
be devoted to supporting capacity building for early
warning, monitoring, and communication systems,
and to designing risk-pooling solutions that reward
preparation.
If incentives are not aligned: Use incremental ap-
proaches to global solutions. When incentives are not
aligned, major sovereigns are not fully engaged, and
the consequences of inaction are potentially cata-
strophicas with climate change and other environ-
mental risks such as loss of biodiversitythe inter-
national community should embrace incremental
approaches that can increase traction toward global
solutions (box 8). To preserve full participation as the
ultimate goal, however, special attention should be
given to steps that can help align incentives toward
a common objective, even if alignment seems very
difcult to achieve. For environmental risks, this ef-
fort may consist of dissemination of knowledge and
advocacy that can help bring diverging views closer,
nancial and technology incentives to countries for
steps such as preventing deforestation and inducing
the use of cleaner technologies, and investments in
research and developmentfor example to construct
methods for counteracting greenhouse gas con-
centration in the atmosphere.
105
In a similar spirit,
the New Deal for Engagement in Fragile States (the
Busan Partnership) recognizes that the risk of non-
engagement can outweigh most risks of engagement
in fragile countries; it outlines a framework in which
the international community can work to help them
strengthen core institutions and policies and reduce
the risk of reverting to conict.
106

An institutional reform to mainstream risk
management
The World Development Report 2014 offers dozens
of specic policy recommendations to improve risk
Cohesiveness through shared preferences and objec-
tives. Mutual recognition of the need to address risks
enables the international community to better pre-
pare for risks that exceed national capacitysuch as
the arrangements to provide emergency lending to
countries facing acute nancing shortfalls, and sup-
port for regional insurance pools like the Caribbean
Catastrophe Risk Insurance Facility.
103
Similarly,
multilateral cooperation for risks that cross bound-
aries works best when the interests of various nations
are well aligned and are not overruled by competing
domestic policy priorities. By helping to align na-
tional interests, the almost universal agreement for
the need to eliminate smallpox facilitated its eradi-
cation. In contrast, in cases where national interests
diverge, such as resolving climate change risks and
alleviating the plight of people living in fragile and
conict-affected countries, progress can be slow.
Power to mobilize resources and enforce agreements.
The international community can have a substantial
impact on the management of risks when there is a
clear goal around which to mobilize resources. For
example, with support from the international com-
munity, early warning systems have helped reduce
deaths from many types of disasters.
104
Similarly,
even if complete international consensus is lacking,
the international community can make progress on
risks that cross boundaries if it can devise mecha-
nisms for enforcing agreements. That capacity de-
pends crucially on the international communitys
ability to realign incentives around shared goals
and to attract participation of major players. A key
element in the success of both the Nuclear Non-
Proliferation Treaty and the Montreal Protocol on
the protection of the ozone layer, for example, were
the threat of security and trade sanctions, respec-
tively, which helped realign national interests and
facilitate participation and action.
How can the international community
improve its contribution?
The insights from the work by Leonid Hurwicz,
Roger Myerson, and Eric Maskin on mechanism de-
sign for institutions are all the more important for
a collectivity as uid, diverse, and complex as the
international community. Considering incentive
constraints (and not only budget and informational
constraints) is critical to devising effective mecha-
nisms for the international community to contrib-
ute to risk management despite its multiple players,
complicated power structures, and diverging goals.
Establish a national risk board to manage risks
in a proactive, systematic, and integrated way
What is the problem? All too often, risk manage-
ment strategies and implementation prove ineffec-
tive (or introduce other risks) because they are not
coordinated among all relevant policy stakeholders.
Managing risk in a proactive and integrated way has
denite advantages: it can help dene priorities, en-
sure that all contingencies have been considered, and
avoid overspending to manage one risk in isolation
while neglecting others. Some countries conduct na-
tional risk assessments that involve multistakeholder
teams from various ministries and often include the
private sector and civil society. The Netherlands,
the United Kingdom, and the United States have
completed this exercise, and other countries, such as
Morocco, have begun a process toward it. However,
this exercise is usually carried out by a temporary,
ad hoc group that exists only while the assessment is
taking place. Other countries have created multimin-
istry bodies in charge of information exchange and
management at different and complementary levels
of society (box 9 provides a summary of these poli-
cies). Its overarching advice, however, is that these
recommendations should be implemented in a pro-
active, systematic, and integrated way to optimize
their effectiveness. For this purpose, the World Devel-
opment Report 2014 advocates establishing a national
risk board, which can contribute to mainstreaming
risk management into the development agenda. This
could be a new agency or come from reform of exist-
ing bodies: what is most important is a change in ap-
proachone that moves toward a coordinated and
systematic assessment of risks at an aggregate level.
Implementing this recommendation may require a
substantial change in the way national governments
develop and implement their general plans, moving
from planning under certainty to considering change
and uncertainty as fundamental characteristics of
modern economies. A national risk board can help
governments overcome the political economy ob-
stacles they face when managing risks at the country
or even international levels.
BOX 8 For certain global risks such as climate change, the international community should embrace
incremental approaches that can lead to global solutions
What is the problem? Management of global risks requires proactive
concerted action by sovereign nations. But limited progress in some
areas has cast doubt on the possibility of fostering collective action
among countries with diverging interests, capacity constraints, and
incentives to free ride. Global negotiations to secure agreements
with full participation have stalledmost spectacularly for climate
change, where persistent inaction could have catastrophic and
irreversible consequences. Some potentially useful international
actionsincluding cooperation to develop and share technologies
and existing fnancial instrumentshave been postponed in the
expectation that they will be part of a soon-to-be-signed global
agreement.
The proposed solution. For certain global risks such as climate
change, the international community should embrace incremental
approaches that can increase traction toward global solutions. When
incentives are misaligned, major sovereigns are not fully engaged,
and the consequences of inaction are disastrous, progress can still be
made outside a multilateral treaty. Incremental deals and actions by
an initially small group of participants can serve as building blocks
to global agreements. By demonstrating benefts from action, the
expectation is that the group would include progressively more par-
ticipant countries over time.
a. UNEP 2007.
b. Falkner, Stephan, and Vogler 2010; Goldin 2013; Hale 2011.
Are there successful examples? Some remarkable examples exist.
The Montreal Protocol to protect the ozone layer was originally
signed by 24 countries but won universal ratifcation during the
1990s with the combined eforts of governments, international orga-
nizations, nongovernmental organizations, and scientists.
a
Likewise,
the Limited Test Ban Treaty, whose signatories expanded from 3 to
119 between 1963 and 1992, paved the way for the more compre-
hensive Nuclear Non-Proliferation Treaty.
How can it be implemented? Country governments, international
organizations, and specialized entities can form a coalition of the
willing to coordinate, advocate, and take action on climate change.
b

The coalition can create incentives for others to join over time by pro-
moting technological change and funding that lowers participation
costs (cheaper ways to reduce emissions, subsidies, or technology
transfers). It can also partner with scientists, civil society, and the
media to induce participants to comply and nonparticipants to join
in. International institutions, including an international risk board,
can provide platforms for policy debate and monitor, report, and
aggregate actions to ensure incremental eforts are on the right
path. Strategically, the coalition could anchor its actions to existing
global frameworks to demonstrate that incremental and global
deals can be connected.
tions about appropriate policies to be implemented.
Institutionalizing the national risk board should add
value by enabling risk management to be integrated
across all sectors, by challenging inaction stemming
from political interests, and by introducing clear ac-
countability mechanisms for implementing agreed
risk management measures.
107

How can it be implemented? The national risk board
should bring together a wide range of stakeholders.
It could be either part of government or an autono-
mous agency. The board composition would include
both policy makers (to reect political priorities)
and independent experts (to incorporate techni-
cal knowledge and private sector perspectives). It
coordination for risk management, but these bod-
ies usually deal with a single riskmost often with
natural disasters, as in Peru, or national security, as
in Israel. Few countries actually have an integrated,
permanent risk management agency that deals with
multiple risks.
What is the solution? To facilitate proactive and inte-
grated risk management at the country level, a na-
tional risk board can be set up as a standing (per-
manent) committee. It can analyze risks, including
trade-offs across risks and across risk management
policies; consider and publish assessments of risk
management practices in the country; dene pri-
orities in risk management; and make recommenda-
BOX 9 Selected policy recommendations from the WDR 2014
The state has an important role in supporting the contributions of
all social and economic systems to peoples risk management. The
following summarizes selected policy recommendations from the
WDR 2014, organized by system, as they are discussed in the Report:
For the household:
Public health insurance, run in partnership with the private sector,
with emphasis on preventive care and treatment of contagious
diseases and accidents
Public education, run in partnership with the private sector, with a
focus on fexible skills, adaptable to changing labor markets
Targeted safety nets for the poor, for instance conditional cash
transfers with payments directly to women
Enforceable laws against domestic abuse and gender discrimina-
tion, accompanied by educational campaigns
For the community:
Public infrastructure for the mitigation of disaster risks, built in
consultation with surrounding communities
Transportation and communication infrastructure, especially to
integrate and consolidate isolated communities
Police protection against common and organized crime, espe-
cially targeted to communities under threat
Enforceable laws against racial or ethnic discrimination, accom-
panied by educational campaigns
For the enterprise sector:
Secure and respected private property rights
Streamlined and predictable regulations for taxation, labor mar-
kets, and entry and exit of frms
Enforceable regulations for workplace safety, consumer protec-
tion, and environmental preservation
Consider the possibility of delinking social insurance (that is,
health and old-age pension) from work status
For the fnancial system:
Sound fnancial infrastructure (payment systems, credit informa-
tion) to facilitate fnancial inclusion and depth
Enforceable regulations that foster both consumer protection and
competition among fnancial institutions
Macroprudential regulation, for the fnancial system as a whole, to
lessen fnancial crises and avoid bailouts
A national fnancial strategy that addresses trade-ofs between
fnancial inclusion, depth, and stability
For the macroeconomy:
Transparent and credible monetary policy, oriented to price stabil-
ity and conducted by an autonomous central bank
For the majority of countries, a fexible exchange rate regime, in a
context of transparent and credible monetary policy
Countercyclical and sustainable fscal policy, aided by an indepen-
dent fscal council
Provision for contingent liabilities, such as natural disasters, fnan-
cial crises, and pensions of an aging population
For the international community:
Engagement in bilateral, regional, and global agreements to share
risks across countries, enhance national capacity, and confront
common risks, favoring pro active and coordinated interventions
For elusive global risks such as climate change, formation of a
coalition of the willing with like-minded country governments,
creating incentives for other countries to join in.
The WDR 2014 advocates that these recommendations be imple-
mented in a proactive, systematic, and integrated way. For this pur-
pose, it proposes establishing a national risk board to help main-
stream risk management into the countrys development programs
and suggests the possibility of an international risk board to support
the coalition of the willing.
the Homefront Crisis Executive Group, comprising
senior representatives from ministries and govern-
ment agencies. This multirisk framework is comple-
mented by agencies focused on specic risks, such
as the National Security Coordination Secretariat.
Singapores institutional arrangement for integrated
risk management involves a great deal of specializa-
tion and a complex coordination process that has
evolved over time. For developing countries, a sim-
pler arrangement that involves less specicity and
specialization in its institutional design (and requires
less demanding coordination mechanisms) may be a
good starting point.
Finally, two important questions should be ad-
dressed. First, what can motivate a government to
institute a national risk board? An initial impulse is
necessary for leaders to overcome opposing incen-
tives and establish a long-term institution. This im-
pulse can come from within the country, through
reform-minded political leaders and technocrats,
and from outside, through incitement and support
from the international community. Once created,
the national risk board can challenge inaction or
poor practices by introducing clear accountability
mechanisms for risk management. A reformist gov-
ernment interested in the continuation of its ben-
ecial legacy may want future governments to be
accountable for their actions or their lack of action.
would have the power to issue act-or-explain rec-
ommendations to relevant authorities responsible
for implementing policythat is, relevant authori-
ties would have to act upon the boards recommen-
dations or explain why they had decided to reject
them. Although the appropriate institutional design
of the board will depend on the countrys political
and institutional context, the boards composition
and powers should strive to achieve an adequate
balance of expertise, credibility, relevance, and legit-
imacythat is, to fall within the balanced region
in diagram 4.
The boards policy makers could be nominated
by the executive branch of government, and the in-
dependent experts could come from academia, the
business community, and civil society organizations.
The boards expertise would cover the areas of mili-
tary, security and terrorism risk; economic risk; envi-
ronmental, health, and technological risk; and social
risk. To avoid becoming a powerless body, the board
should have sufcient prominence in the public eye.
And it should be held accountable by regularly pub-
lishing its recommendations accompanied by analy-
sis and statements of policy priorities and by being
subjected to annual hearings in front of a legislative
committee.
While an autonomous national risk board may
have certain advantages, the board could also func-
tion as part of government. Indeed, countries as
different as Jamaica, Mali, Mexico, Morocco, and
Rwanda are considering establishing an integrated
risk management function within the government
structurein part following a proposal by the World
Economic Forum to establish a country risk ofcer,
similar to the position of chief risk ofcer that has
been created in many multinational companies.
108

This institutional design could be practical in coun-
tries with a strong framework for an effective and in-
dependent civil service, with the national risk board
members appointed as expert technocrats with guar-
anteed positions for periods that extend beyond the
political cycle.
Singapores Whole-of-Government Integrated
Risk Management framework is an example of an
approach that has overcome silos within the gov-
ernment.
109
The institutional umbrella of the frame-
work is the Strategy Committee, composed of per-
manent secretaries from various ministries across
government and chaired by the Head of Civil Ser-
vice. In addition, the Homefront Crisis Management
system includes a ministerial committee chaired by
the Minister of Domestic Affairs and supported by
DI AGRAM 4 Balancing the trade-offs in the institutional
design of a national risk board
Lower
credibility
Independent
experts
Lower
legitimacy
Lower
relevance
Advisory
role
Implementation
role
Policy
makers
Lower
expertise
Balanced
region
the enterprise sector to grow, develop, and provide
risk management resources to the entire population.
Third, an internally fragmented government that
lacks organization and coordination may end up
with ambivalent policies or ineffective implemen-
tation. This may occur, for instance, as result of a
defective decentralization process, where local and
regional governments do not have the necessary re-
sources and capacities to fulll their responsibilities,
do not share the priorities and preferences of the na-
tional government, or attempt to free ride on other
local and regional governments.
Finally, the government may be guided by ideol-
ogy, wishful thinking, or simple desperation when
confronting difcult and genuine problems, instead
of relying on measures based on good evidence and
analysis. A common example is labor market regu-
lations that purport to defend workers interests but
wind up protecting only a few and contributing to
the roots of a large informal sector. Inationary -
nancing of budget decits or variable and inconsis-
tent macroeconomic policies in the face of crisis are
other examples: sooner rather than later, both paths
lead to increased uncertainty, macroeconomic insta-
bility, and possibly even protracted recessions.
2. Provide the right incentives for people and
institutions to do their own planning and
preparation, while taking care not to impose
risks or losses on others
The challenge for public policy is to create incentives
for people to do their own risk planning and prepa-
ration, avoiding circumstances in which benets
are privately appropriated but losses are imposed on
others.
Consider nancial bailouts. They are detrimen-
tal not only because they can produce a large scal
burden but also because they provide incentives
for excessive risk taking. Yet bailouts are sometimes
necessary to prevent a systemic collapse of nancial
intermediation. Bailouts should be avoidedmost-
ly by using well-established, clear, and transparent
macroprudential policiesbut if bailouts occur, they
should be designed to avoid providing the wrong
incentives for the future. Good examples of orderly
nancial bailouts are hard to nd, but the Turkish
experience in the wake of the 200001 banking crisis
(and especially the unwavering stance of the coun-
trys bank regulatory and resolution agencies) offers
a case to analyze and follow.
110

In a very different realm, social protection can be
criticized for not encouraging personal self-reliance
The second question is whether a similar body
can be created at the global levelan international
risk boardto help address risks that cross national
boundaries. An international risk board could in-
volve the scientic and expert community around
the world to pool all available knowledge to iden-
tify, assess, and manage major global risks. Its major
drawback would be that, in the absence of a gov-
erning body at the international level, it could lack
implementation relevance. That could be remedied,
however, if the international risk board were to work
in conjunction with the coalition of willing coun-
tries (see box 8), setting priorities on issues to be
tackled urgently and offering credibility and legiti-
macy to its efforts.
In conclusion: Five principles of public
action for better risk management
Analysis throughout the World Development Report
2014 suggests that, to improve the quality and de-
livery of social protection, public goods, and public
policy that are essential to supporting peoples risk
management, public action can usefully be guided
by some key principles. The ve principles that fol-
low reect the lessons from best practice around the
world and are relevant for different types of risks
and countries. Their application should be tailored
to specic contexts, however. Although at rst glance
these principles may appear uncontroversial, in ap-
plication they involve tensions and trade-offs that
make their implementation a challenge.
1. Do not generate uncertainty or unnecessary
risks
The states policies and actions should strive to re-
duce risks and lessen uncertainty. At a minimum, the
state should not worsen them. How or why would
a government do that? First, through its policies,
it may perpetuate social norms that discriminate
against certain groups and make them more vulner-
able. For example, state policies that promote gen-
der inequality or ethnic favoritism harm, rather than
help, household and community resilience.
Second, the government may favor the group that
supports it politically, whether a small elite or large
constituency, against the legitimate interests of oth-
ers. For instance, states that expropriate nancial as-
sets (like savings and pension funds) or private infra-
structure (like residential buildings or factories) from
some households may obtain short-run gains but end
up hampering the ability of the nancial system and
4. Promote exibility within a clear and
predictable institutional framework
Flexibility in adjusting to new circumstances is es-
sential to promoting resilience and making the most
of opportunities. Prime examples include household
migration in response to shifting economic trends,
rural communities adaptation to climate change,
and enterprise renewal in the face of technological
and demand shocks. Flexibility should not imply
arbitrary discretion or haphazard responses, how-
ever. A challenge for the state is to promote exibility
while preserving a sensible, transparent, and predict-
able institutional structure.
For enterprises, the Danish model of exicurity
offers such balance, combining ease of hiring and r-
ing of workers alongside a strong social safety net and
reemployment policies. The result is a dynamic econ-
omy with high turnover in employment but short
spells of unemployment. For the macroeconomy,
ination targeting regimes with oating exchange
rates offer a good model of exible yet institutionally
sound monetary policy. By 2012, 27 countries around
the world had adopted an ination targeting regime.
With the onset of the European Monetary Union in
1999, many countries that had practiced ination
targeting in the 1990s abandoned the regime. Given
the prolonged recession and uncertainty in the Euro
Area, monetary exibility could have been a useful
tool these countries no longer have.
5. Protect the vulnerable, while encouraging
self-reliance and preserving scal
sustainability
The harsh reality is that throughout the world, many
people do not have the material resources and in-
formation necessary to confront the risks they face.
The everyday struggle to eke out a living can make
planning ahead hard for the poor. The challenge for
the state is to protect the vulnerable while preserving
scal sustainabilityand encouraging self-reliance.
For households that remain highly vulnerable to
shocks, the state can provide safety nets to replace
the costly coping mechanisms that undermine con-
sumption, human capital, and productive assets.
Safety nets are possible even in low-income coun-
tries, provided the support is targeted to vulnerable
populations and is designed to incentivize work ef-
fort. Ethiopias Productive Safety Net System, for ex-
ample, demonstrates how a well-designed safety net
can protect millions of households from food inse-
curity while investing in community assets.
and being an unsustainable burden to the state. The
evidence, however, demonstrates that these prob-
lems can be avoided by a design that takes peoples
incentives directly into account. Well-designed safety
netssuch as conditional cash transfers or workfare
programs, as implemented in Bangladesh, Brazil,
India, and Mexico, to name a fewhave promoted
better household practices in the areas of education,
health, and even entrepreneurship, while remaining
scally sustainable.
111

In all cases, to manage risks effectively, two
changes in peoples mindset related to individual
and social responsibility are critical: moving from
dependency to self-reliance, and from isolation to
cooperation. Providing the right incentives can con-
tribute in both regards.
3. Keep a long-run perspective for risk
management by building institutional
mechanisms that transcend political cycles
A major challenge for public action is to establish
institutional mechanisms that induce the state to
keep a long-run perspective that outlasts volatile
shifts in public opinion or political alliances. For in-
stance, the states provision of education and health
services is a large investment in risk preparation for
families and communities that must be funded on
a continuous and sustainable basis to succeed: that
entails long-run planning. In the case of health ser-
vices, Thailand and Turkey offer successful examples
with their recent shift to universal health insurance
programs.
Consider also the following two examples from
nancial and macroeconomic policy. For the -
nancial system to support risk management, it is
essential to strike the right balance between inclu-
sion and stability. This balance can be assessed only
through comprehensive long-run planning, like that
being done in Malaysia, where the strategy for the
nancial sector is prepared by the central bank, in
collaboration with the ministry of nance and the
private sector. Countercyclical monetary and scal
policies also require a long-run perspective, which
allows them to manage the business cycle by using
resources built over a prolonged time and in dif-
ferent scenarios. Best practice suggests targeting a
long-run budget balance, as Chile, Colombia, and
Norway, among others, are doing. Institutional
mechanisms that transcend the political cycle
such as a national risk board and an independent
scal councilcan help maintain a long-run focus
on risk management.
and opportunities that lie at the heart and core of
modern life. So too can the fate of communities and
countries improve, if they share the continuous re-
sponsibility required to manage risk successfully.
I grew up in a war environment. And what I learned
is that you can plan your fate, at least to some degree, if
you assess your risk and do something about it.
Klaus Jacob, disaster risk management expert
at Columbia University and World War II
survivor
112
There was a time I used to walk to work every day.
The route I had to take was dangerous, and many peo-
ple were victims [of] robbery and physical abuse. So,
yes, I have overcome risk to pursue opportunity.
Kariuki Kevin Maina, student, Kenya
Contribution to the WDR 2014 website
The international community can also provide
support to vulnerable populations with resources
and expertise. Although much criticized, foreign aid
has been successful when provided in coordination
with accountable local institutions. Such was the case
when foreign aid helped rebuild infrastructure and
establish early warning systems in Indonesia after the
2004 tsunami.
At the end of the day, protection of the vulnerable
entails taking the measures necessary for sustainable
developmentdevelopment that eliminates extreme
poverty and allows people to escape vulnerability
through the sustained growth that risk management
can offer.
Some closing thoughts
The fate of individuals and families can change for
the better if they plan and prepare to face the risks
exacerbated the Great Depression (Eichengreen and Irwin
2010). However, the international community has been less
successful in avoiding export restrictions during the food
price crises in recent years (Martin and Anderson 2012).
37. Knight 1921.
38. Hallegatte and others 2012.
39. ihk and others 2012.
40. For a review of the literature on risk sharing and family and
network formation, see Fafchamps 2011.
41. Acemoglu and Robinson 2012 compile many examples of
such failures.
42. Reinikka and Svensson 2005; Speer 2012; Devarajan, Khemani,
and Walton 2011.
43. Becker 1993.
44. Oviedo and Moroz 2013 for the WDR 2014.
45. De Weerdt and Hirvonen 2013 for Tanzania; Yang and Choi
2007 for the Philippines; Paulson 2000 for Thailand.
46. WDR 2014 team based on OECD Programme for Interna-
tional Assessment (PISA).
47. Xu and others 2003.
48. Demirg-Kunt and Klapper 2012.
49. Duo 2003; Thomas 1990.
50. Duo 2003; see also Thomas 1990 and Lundberg, Pollak, and
Wales 1997.
51. WDR 2014 team based on World Bank World Development
Indicators (database).
52. World Bank 2005.
53. Thoresen and Fielding 2011 show how expanding health
care coverage can put considerable pressure on the sustain-
ability not only of scal resources, but also human resources.
54. Premand 2013 for the WDR 2014.
55. Paxson and Schady 2007 and references therein; Macours,
Schady, and Vakis 2008; see also references in Fiszbein and
Schady 2009.
56. WDR 2014 team based on Demographic and Health Surveys.
57. Coleman 1988; Putnam 1993.
58. De Weerdt 2001.
59. Gertler and Gruber 2002.
60. For example, Aldrich 2011 shows that social capital plays
a key role in communities ability to recover from natural
disasters.
61. Alesina, Baqir, and Easterly 1999.
62. Narayan, Pritchett, and Kapoor 2009; Bowles and Gintis
2002.
63. Bjorkman and Svensson 2009; Pandey and others 2007.
64. Knight 1921; Coase 1937.
65. For seminal papers on the topic, see Baily 1974 and Azariadis
1975.
66. Schumpeter 1942.
67. Hsieh and Klenow 2009.
68. Baicker, Cutler, and Song 2010.
69. Bergoeing, Loayza, and Repetto 2004.
70. An interesting example of formalization leading to both en-
hanced environmental protection and higher incomes has
recently occurred in Peru. In recent years, informal mines in
Peru have sprung up in response to rising gold prices. Ignor-
ing existing regulations, these informal mines have caused
signicant deforestation. The mercury used in the extrac-
tion process has contaminated rivers and the atmosphere
and threatened human health. In the La Libertad region, the
Poderosa Mining Company took an innovative approach to
the problem after informal miners invaded one of its mining
concessions. The company began to formalize the invading
Notes
1. Dercon, Hoddinott, and Woldehanna 2005.
2. Buvini and Morrison 2000.
3. World Bank 2012d.
4. WHO 2013.
5. Baulch 2011 offers a useful survey.
6. Paul 2009.
7. Didier, Hevia, and Schmukler 2012.
8. Dercon and Christiaensen 2011.
9. See Karlan and others 2012 for Ghana; and Cole, Gin, and
Vickery 2013 for India.
10. Hoddinott, Rosegrant, and Torero 2012.
11. Hallegatte 2012a.
12. While the costs of preparing for risk must be incurred pre-
dominantly up front, the benets tend to accrue over time
and are therefore more uncertain. The probability of a risk
materializing is thus central to any assessment of a potential
intervention. In formal benet-cost analyses, this probability
is usually taken into account either implicitly (by basing cal-
culations of averted costs on average historical data) or ex-
plicitly (by weighting the potential benet of a risk manage-
ment intervention in the event of a shock by the probability
of that shock occurring). See Wethli 2013 for the WDR 2014.
13. See, for example, Bodie, Kane, and Marcus 2011.
14. See Kuznets 1955 and Dasgupta and others 2002. The trade-
offs mentioned in the text are perceived to exist by some ex-
perts and a large share of the public, as reected in opinion
polls, but may not be present in reality. Recent analyses nd,
for instance, that economic growth and environmental pro-
tection as well as social inclusion are often complementary.
See World Bank 2012b.
15. Hoddinott, Rosegrant, and Torero 2012.
16. Dethier, Hirn, and Straub 2011; Kehoe and Prescott 2007.
17. Bruno and Easterly 1998.
18. Bernoulli 1738; von Neumann and Morgenstern 1944.
19. Allais 1953; Kahneman and Tversky 1979.
20. Black 1948; Buchanan and Tullock 1962; Olson 1965.
21. Hurwicz 1960; Myerson 1979; Maskin 1999.
22. The concept of a risk chain is discussed and illustrated in
Alwang, Siegel, and Jrgensen 2001. See also Barrett 2002;
Heltberg, Siegel, and Jrgensen 2009.
23. Ehrlich and Becker 1972. See also the extension in Muer-
mann and Kunreuther 2008 and the applications in Gill
and Ilahi 2000; Holzmann and Jrgensen 2001; and Packard
2002.
24. Khokhar 2013 for the WDR 2014.
25. World Bank World Development Indicators (database).
26. World Bank 2012c.
27. For a rich discussion of the potential complementarity be-
tween insurance and protection, see Erlich and Becker 1972.
28. Economist 2013.
29. Hallegatte 2012b.
30. Carter and others 2007.
31. FEMA 2010.
32. Gourinchas and Obstfeld 2012; Schularick and Taylor 2012.
33. Hallegatte 2012b.
34. La Porta and others 1998.
35. See, for example, Tornell and Velasco 1992.
36. This kind of trade retaliation was avoided during the
200809 global nancial crisis, in part because of successful
coordination by the international communityin contrast
to the well-known beggar-thy-neighbor trade policies that
92. Kaminsky, Reinhart and Vgh 2005.
93. Parker 2011.
94. See Kraay 2012 and Ilzetzki and Vgh 2008 for surveys of the
literature on developing countries; and Barro and de Rugy
2013 and Ramey 2011 for surveys of the literature on devel-
oped countries.
95. Laeven and Valencia 2012.
96. DFID 2005; OECD 2011a, 2012; World Bank 2011.
97. OECD 2012.
98. DFID 2005.
99. See Resilience Stories at the Sendai Dialogue website at
https://www.gfdrr.org/node/1308.
100. Larrimore and Sharkey 2013.
101. Not all risks that exceed national borders are truly global.
Some risks, such as armed conict between neighboring
countries or disputes over natural resources, may affect only
a few countries. Such risks may be more appropriately or ef-
fectively managed by regional institutions.
102. Jonas 2013 for the WDR 2014.
103. Mahul and Cummins 2009.
104. World Bank and United Nations 2010.
105. Royal Society 2009.
106. OECD 2011b.
107. Graham and Wiener 1995; World Economic Forum 2007.
108. World Economic Forum 2007.
109. OECD 2009.
110. Damar 2007; Ersel and Ozatay 2008.
111. Fiszbein and Schady 2009; Alderman and Yemtsov 2012.
112. Quoted in Eric Klinenberg, Adaptation: How Can Cities be
Climate-proofed? The New Yorker, January 7, 2013, 33.
miners, signing agreements that allowed them to continue
mining under its direction. The agreements, which meet in-
ternational environmental management quality standards,
have increased the small miners income and decreased
the harm from deforestation and mercury contamination.
UNEP 2012.
71. World Bank 2012d; Loayza and Rigolini 2011.
72. Caldern and Fuentes 2012.
73. Caballero and others 2013.
74. Miller 1986.
75. Diamond and Dybvig 1983.
76. Laeven and Valencia 2012.
77. Han and Melecky 2013 for the WDR 2014; Cull, Demirg-
Kunt, and Lyman 2012.
78. Brix and McKee 2010.
79. Gupta 2013.
80. World Bank 2012a.
81. Borio 2003 provides a discussion of the differences between
a traditional, microprudential regulatory framework and a
macroprudential regulatory approach.
82. Maimbo and Melecky 2013 for the WDR 2014.
83. Barro 2009.
84. Hnatkovska and Loayza 2005.
85. Easterly and Servn 2003.
86. Prasad and Gerecke 2010.
87. Education International 2009.
88. Svensson 2012; Bruno and Shin 2013.
89. Edwards and Levy Yeyati 2005.
90. Ramcharan 2007.
91. Edwards 2004; Lane and Milesi-Ferretti 2012; Ghosh,
Qureshi, and Tsangarides 2013.
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World Development Report 2014 (Overview)

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OVERVIEW

Risk and opportunity

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